Exchange innovation

March 17, 2017 01:00 PM


Equity exchanges made some noise in early 2017 as upstart IEX made itself known (see “A growing concern,” below). How can we tell?  Other exchanges are replicating their model? 

Intercontinental Exchange (ICE), parent of the New York Stock Exchange (NYSE) made a series of announcements in early 2017 that highlighted both the past and a commitment to the future. 

NYSE is expanding its enigmatic floor operations to all listings and sub-exchanges. “This move represents continued significant investment by ICE in the NYSE trading floor operations to bring greater value, transparency and efficiency to the U.S. equity markets,” noted a release. “NYSE Arca Equities already offers trading in all U.S. securities. NYSE MKT will expand to include trading in all U.S. securities when it moves to an electronic price/time model in the second quarter of 2017.”

ICE may be best known as the grim reaper for exchange-floor trading, so this came as a bit of a surprise; but NYSE COO Stacey Cunningham says it is part of a long-term commitment. “The ICE management team has repeatedly gone on the record to say that we are committed to the NYSE model and floor-based trading because it combines technology and human judgment to deliver the best possible trading outcomes, market quality and a service offer to listed issuers 
that is completely unique to the New York Stock Exchange,” Cunningham says. “This reflects an expansion of both electronic and floor trading operations, and means NYSE Floor Brokers will be able to offer their clients the benefit of parity in securities listed on all U.S. equity exchanges.” 

NYSE expects that by the end of 2017, investors will be able to trade all U.S. securities (Tape A, B and C) on all their venues, including NYSE and NYSE American (formerly MKT). Trading of all U.S securities is already available on NYSE Arca. 

Part of the rollout included rebranding NYSE MKT as NYSE American and recommitting that platform to servicing small- and mid-cap companies, which were historically served by the American Exchange (AMEX), the forerunner to NYSE MKT and American. 

“Our equity markets strategy aims to deliver greater choice for corporate and ETF issuers and to investors by offering unique exchange venues,” Cunningham says. 

Key to that strategy is the transition to NYSE American, which is designed exclusively for small and mid-cap companies. 
They also plan significant changes to their market model, including offering an IEX style delay. “NYSE American will file rules with the SEC for new features that promote midpoint trading, including a 350 microsecond delay upon order entry, proprietary data and outbound routing, as well as a discretionary pegged order,” Cunningham says. 

This seems odd as ICE — along with several other established equity exchanges — had waged a very public battle encouraging the Securities and Exchange Commission to reject the IEX exchange application on the grounds its 350 micro-second delay violated Regulation NMS. 

“Our trading member firms have told us that they are interested in these types of functionalities for a segment of their order flow. We believe the changes we are making will attract liquidity for our small- to mid-cap companies, and attract more listings,” Cunningham says. 

John Ramsay, chief market policy officer for IEX, says. “They say imitation is the most sincere form of flattery, so in some sense we feel flattered, but the SEC in approving IEX said you have to look at each proposal on its own merits. The SEC never said all speed bumps are approved.” 

Ramsey points out that the NYSE speed bump is quite different because it uses software to create the bump rather than the IEX method of a physical coil organically delaying the execution time of orders. “The advantage of that is that the delay is what we call deterministic. It helps to ensure that it is the same amount every time. It is an important part of our design that everybody knows is going to react the same way to every order. By doing it with software it means there can be more variation,” Ramsey says. “They looked at our specific design and all of the details were hashed out over a nine-month period. Not all speed bumps are created equal and not all speed bumps will be approved.”

While IEX expresses a fair amount of exasperation that NYSE would seek to replicate the delay after fighting so vigorously against it; the simple fact is that they were approved, so competitors were bound to step in and compete for those customers. It feels it gives them an edge, or more accurately provides a more even playing field with high-frequency traders. 

“Our position on IEX’s exchange application was driven by our belief that an intentional delay was inconsistent with Reg NMS’ requirements for a protected quote and that a change in interpretation would result in increased complexity,” Cunningham says. “The SEC has determined that this specific implementation of an intentional delay is permitted, so we will set aside our disagreement with their interpretation and move forward. We recognize that the buy-side finds value in dark trading, particularly if they are working an illiquid name and want to be passive during a long period. The intentional delay model has proponents and we believe it can be valuable for specific institutional investors.” 

And they are not the only ones. The Chicago Stock Exchange (CHX), which is in the process of being acquired by a syndicate that includes Chinese business interests, is rolling out several new market structures, including a speed bump they call the Liquidity Taking Access Delay (LTAD), which is currently under review with the SEC (see “Manchurian exchange acquisition,” below). 

“The LTAD is a speed bump designed specifically to protect displayed liquidity,” says Anthony Saliba, a CHX board member and a member of the investment group acquiring CHX. “The delay applies equally to all liquidity-taking orders, protecting investors from latency arbitrage and allowing for liquidity providers to create tighter and deeper markets in a safer manner.” 

Ramsey says the CHX model is very different because the delay is only on one side of the market. He also stresses that the speed bump is only a small part of the IEX value proposition. 

“The bigger point is that the so-called speed bump is just one isolated part of our design — it is an important one but just as important to delivering fairness to investors in the fact that we don’t pay rebates, we don’t charge people to get faster access to our exchange, we don’t sell market data to the highest bidder to enable speed-based strategies and we don’t have a lot of complicated order types that can be used by high-speed traders,” Ramsey says. “All of those things are really important, too. “It is fine if they want to copy us on the speed bump, but they aren’t doing any of the other things that we think are vital to actually delivering a better result to investors.”

From the NYSE perspective, it is about offering choices to investors. Our aim is to provide the buyside with choice among market models, and now they will also have a choice of using our market for an intentional delay,” Cunningham says, which includes discretionary pegged orders. “Being able to offer a discretionary pegged order with crumbling quote protection represents a shift in the type of functionality exchanges have previously been permitted to provide. We are interested to offer this feature because we believe it will provide customers with the option to passively participate with contra-side order flow, with the exchange monitoring the quality of the quote on their behalf,” Cunningham says. 

“We are glad that NYSE seems to have finally acknowledged that speed bumps are not bad in and of themselves and we are not concerned with whatever version they want to adopt,” Ramsey adds. “We might be more worried if they decided to cut out selling market data and all the rest.”


Manchurian exchange acquisition

If you heard about the acquisition of the Chicago Stock Exchange (CHX) it is probably because the acquirers — substantially funded from Chinese business interests — have created a bit of a stir. CHX Board Member Anthony Saliba, who is also involved in the acquisition, says, “The ratio of media mentions to deal value has been extreme since it was announced early last year. This is a relatively small deal and it’s getting all sorts of media attention because Chinese entities are involved.”

Saliba says the proposed sale has been sensationalized because of the China component—noting that the buyer has been misidentified as the Chinese government in some reports — but the actual offer is from a syndicate that includes American and Chinese business interests.

“China” is not buying anything. The investment group is led by Chongqing Casin Enterprise Group, a private company with no ties to the Chinese government,” Saliba says. “Deals with foreign entities should certainly not occur without governmental due diligence, but concerns that Casin is an actor controlled by the Chinese government have been researched, vetted and debunked by the Committee on Foreign Investment in the United States (CFIUS).”

Saliba’s career in the securities industry spans nearly 40 years and includes collaboration with exchanges throughout the globe. He is excited about many of the innovations currently under way at CHX and says the investment this deal represents will breathe vital working capital into the exchange, allowing CHX to invest further in improving market structure and allow CHX to compete.

In addition to the LTAD, CHX has introduced SNAP, an on-demand auction that executes trades based on the best price, rather than the fastest speed. Saliba says SNAP levels the playing field for traders. “These auctions take place in the dark to minimize information leakage, yet  —  unlike dark pools  —  offer the safety of a fully-regulated exchange,” he says.

Saliba say the biggest CHX initiative is a listing program for medium and small businesses that will serve as an alternative to the opaque world of crowdfunding. “These companies will gain access to capital via an avenue that currently doesn’t exist, and their investors will be protected by going through an SEC-regulated exchange.”

Our market system  —  and really, our nation  —  is based on the philosophy that competition is best for all involved. This acquisition will give CHX a foothold to seriously compete as a securities exchange. CHX does not command a large market share today, but it is unique in its independence  —  almost all of the other exchanges are owned by NYSE or Nasdaq,” Saliba says. “If CHX can get the funding it needs to launch its planned initiatives and compete with the giants in the field, all other exchanges would be incentivized to improve as well. And all market participants would reap the benefits.”

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.