The addition of high speeds and multiple execution venues has altered the equity market structure in recent years. Now the SEC is weighing in with newly proposed rules on dark pools. Meanwhile, IEX, which rose to fame with Michael Lewis‘ Flash Boys, is trying to move from dark pool to full-fledged exchange. Keith Ross of PDQ Enterprises says transparency is a good thing, and a market pause has its benefits in alternate venues, but as an exchange could create chaos.
When the Securities and Exchange Commission published its Regulation National Market System (Reg NMS) in 2005, only a small fraction of equity volume was crossed on alternative trading systems. Nowadays, upwards of 40 percent of the volume can be transacted on ATSs. Many have argued that the regulatory burden of dark pools has been light compared to that of lit exchanges such as the New York Stock Exchange and NASDAQ.
In November 2015, the SEC issued a proposed rulemaking on alternative trading systems, with a request for comment on 558 questions about how such rules should be implemented, the logistics of the required filings, the impact on market structure, and a host of other considerations. PDQ submitted one of the 25 comment the commission received. Afterward, Ross spoke with John Lothian News about the proposed rules.
“Being an ATS is not going to be a picnic anymore,” says Ross, “but the cost is not going to be that high. If that is the tipping point for you to decide not to go into business as an ATS, you probably weren’t supposed to be in it anyway.” He says that, if the rules increase customer confidence in ATSs by adding a level of transparency and addressing concerns of conflict of interest by broker-dealers who also act as market makers, it will be well worth the expense.
Ross also weighed in on another hot topic in equity market structure – rival dark pool IEX and its bid to move from ATS to full-fledged exchange. He first explains the differences between PDQ, which uses a “structural pause” versus IEX, which has built in a “speed bump” over which all posted quotes must pass.
When a participant wishes to source liquidity in PDQ ATS, a request for trade (RFT) is generated – symbol only, meaning no quantity or directional information is sent – and other participants are given a few milliseconds to respond. “Much as in the pit you would say, ‘how’s Dec Wheat?’ The crowd would respond, and who is first and who is best would get the trade,” says Ross.
He calls IEX’s speed bump “a technological impediment to an efficient market.”
He says, as a dark pool, IEX is free to institute a speed bump, and it should be other participants’ choice as to whether they wish to trade on such a venue. The issue is IEX’s idea to move from ATS to exchange. Ross says that, “what they see as a benefit actually becomes a hindrance to the public market.” Should IEX become an exchange, everyone will be required to send the order to IEX for possible execution, per Reg. NMS, which requires all orders to be filled at the “national best bid or offer” (NBBO). But because of the speed bump, participants will be seeing stale quotes or “ghost quotes” as he calls them.
“The commission is in a tough spot,” says Ross. Approving IEX’s application “would lead to chaos,” according to Ross, but forcing IEX to remove the speed bump would remove IEX’s point of differentiation. The other choice would be to change the rules to accommodate IEX, but other platforms have, in the past, been denied similar requests.
Ross believes that, while there are some liquidity issues in the market, our markets have never been more efficient, and that part of the success can be attributed to ATSs, which he says continue to be a source of innovation. He sees venues like PDQ as a way to “move beyond the speed race” to solve remaining liquidity issues.