One of the main problems with the current equity market structure that pushed Brad Katsuyama, global head of electronic sales and trading at RBC Capital Markets, to apply for a new exchange, ironically enough, is that there are too many trading venues.
Liquidity is disbursed across more than 50 venues, which can create inefficiencies that can be exploited by high-frequency traders.
“One of the issues with market structure is there are too many venues; back in the old days when 90% of the volume was at the NYSE you could go there and get most of [the liquidity that] was available,” says Keith Ross, CEO of dark pool PDQ ATS.
Ross sees many of the same problems as Katsuyama and PDQ has come up with a different way to address it.
PDQ is a dark pool, meaning it does not post bids and offers but is also unique in the dark pool space. Customers do not send orders, they simply make a request for quote—that is PDQ sends the symbol of the stock or ETF a customer wants to trade to its group of dedicated market-makers. Any such request is predicated on the fact that there is a marketable order (within the NBBO) on the other end but the market- makers do not know if it is a buy or sell or the size.
“Essentially we say to them, ‘where are you in Microsoft?’ and they will respond ‘I am $46 bid for 500, I will sell 500 at $46.02.’ And we will aggregate the responses from everyone that is interested in Microsoft and create a price time priority book so the best price will fill the client’s order,” Ross says.
There is a 20 millisecond delay, which allows for the aggregation of all the bids and offers from market makers.
Ross says that the market, which launched in 2009, solves many of the problems Katsuyama cited for creating IEX and the results have been a 45% rate of price improvement for orders executed on PDQ, much higher than the industry norm.
He says that they solve many of the common problems with order execution because orders have to come to PDQ instead of them having to chase them.
“I described the running around to different venues as whack-a-mole; we reverse the flow of the river so to speak,” Ross says. “If those shares are going to trade with your order they have to come to PDQ and once they come they are actual executable orders. We pull them all together and trade with them all at one time.”
If a customer does not have a match the PDQ can send it out or cancel it depending on the customer’s wishes.
Ross says many of their market-makers, that typically make markets over several exchanges and dark pools, would be classified as HFT. “We would argue that—even better than IEX—they really have no ability to game the order. We don’t have artificial barriers like IEX does but we do make them compete with each other to offer the best price.”
Competition is the key and Ross says they are attempting to create a virtual trading floor.
“In essence we think that we recreate the competition of the floor in our virtual electronic crowd. No one else has visibility to it. And each order receives a custom auction.”
PDQ has grown steadily and is profitable according to Ross, but is still quite small with less than 1% of equity market share.
PDQ is cheaper that the lit market for customers but does not offer as great a rebate to market makers. “Our pricing to our liquidity seekers is about 30% or 40% less that the lit market and the comparable rebate to the providers is also less but they don’t have to post to the market in advance, they have the option to respond to the order,” Ross says. “Some of our orders we do give rebates but the majority are free for the provider and a cost to the takers.”
Most of PDQ’s customers are retail but they are adding a new “Auction One” facility to draw in the buyside. Instead of a 20 millisecond delay they will delay the market a full second and require a minimum order size of 2,500 shares. Market-makers will be required to provide a size of at least 500 and they will be able to aggregate liquidity from other dark pools.
“[The buyside] have the problems of the fragmented whack-a-mole market, we reverse the flow, we consolidate orders from different venues and give you the capability of trading with it all at the same time so that you get more liquidity at your price,” Ross says. “If we have 5,000 to buy and we trade 1,500, if the customer cancels the remaining 3,500, the people that traded the 1,500 have no idea whether they filled the order or not because we don’t show them the size, we only show them the symbol that we have marketable shares in that particular stock.“
The changes wrought by Reg NMS have created competition and innovation according to Ross. But it has also fragmented the market, which has made it difficult to execute size without moving the market. Like IEX, PDQ is looking to bring the market together in an efficient manner.