The majority of buy-side traders are in favour of pre-trade transparency for actionable IOIs, the results of the latest theTRADEnews.com monthly online poll suggest. A total of 58% of respondents to our April poll agreed that actionable IOIs (indications of interest) should be subject to pre-trade transparency requirements.
In the US, the Securities and Exchange Commission (SEC) is currently considering feedback from market participants to its proposal, issued in the fourth quarter of last year, to publish actionable IOIs as quotes alongside bids and offers on the US’s consolidated price tape.
The proposal sits beside two others designed to increase transparency in US dark pools – first, lowering the level at which dark pools must make quotes public to 0.25% of a stock’s average daily traded volume (from 5%) and, second, forcing dark pool operators to report trading volumes individually on the consolidated tape – although orders of US$200,000 or more are exempted from all three of the requirements of the planned ‘Regulation of Non-Public Trading Interest’. Separately, the SEC has also proposed closing the loophole in Regulation NMS that allows ‘flash’ orders. US exchanges Nasdaq and BATS have already dropped similar order types.
The traditional indication of interest has always been viewed with healthy scepticism by buy-side traders that are aware of its openness to manipulation by brokers looking to drum up business, but the actionable IOI – broadly an IOI that contains sufficient information for a trade to take place without further negotiation – has come under scrutiny as an agent of a two-tier system in the equities market. Particularly in the aftermath of a global financial crisis triggered in part by financial instruments that turned out to be worth considerably less than face value, transparency is of paramount importance to regulators. In this context, it is inevitable that the SEC would seek to alter the definition of bids and offers in Reg NMS to include actionable IOIs, thereby placing them on the national US pre-trade consolidated market data feed, making the information available to all market participants.
“I’m not surprised by the results of the poll,” says Vlad Khandros, a member of the Corporate Strategy Group at Liquidnet, the buy-side crossing network provider. “There is a terrible market perception of IOIs. Most market participants view IOIs as advertisements rather than as a way of safely sourcing liquidity on an anonymous basis. Liquidnet uses IOIs as a way for members to source additional liquidity without forcing them to show their hand, but the low general perception of IOIs suggests that some providers use IOI in a way that doesn’t benefit their clients.”
Khandros, who been working closely with the firm’s general counsel on Liquidnet’s submissions to the SEC, suggests that the SEC’s concerns over the emergence of a two-tier market needs to be tempered by a longer-term view of market trends.
“The SEC is very concerned about perceptions of cash equities as a two-tier market,” he says. “That term is used regularly despite the fact that the overwhelming majority of US cash equities volumes remain on registered exchanges. Indeed the historical 70/30 split between on- and off-exchange trading still holds true today. All the data shows that trading costs have gone down and the market has never been this efficient, but there’s always room for improvement. We do feel there is a need for more transparency, but the more specific the rules, the easier they are to get around, and that might not serve the market in the long term.”
With many of its users focused on block trading, Liquidnet has encouraged the SEC to be more flexible in its approach to exemptions. While the regulator’s proposal that orders for US$200,000 should be exempt from the proposed planned ‘Regulation of Non-Public Trading Interest’ is widely considered appropriate for large stocks, Liquidnet and others have urged the SEC to consider a different measure for small- and mid-cap stocks, perhaps based on number or percentage of shares.
Signs are that the SEC is sympathetic to this argument, but a secondary consideration is the reaction of regulators elsewhere. In April, the Committee of European Securities Regulators, called for evidence of use of IOIs – and other technology-enabled trading practices – in Europe.
“One of our biggest concerns is that what the SEC does will be watched very closely by other major regulators across the world,” says Khandros. “It’s clear to us that if there are decisions taken here in the US that raise the cost of trading for institutions, they may well influence other decisions made globally.”