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CHX: Ownership Matters

Chicago Stock Exchange Seeks Transformation in New Owners and Trading Processes

With over 50 venues in the U.S. to execute trading of shares of stock, the Chicago Stock Exchange (“CHX”) unfortunately only stands out for its being overlooked. Its management seeks to change that with an ownership overhaul, trading technology process innovations and a push back into listings that could attract Chinese companies, among others.

Like a little brother who gets forgotten in a big family, CHX is fighting for attention with its plans. Many of its current owners have stakes in other trading venues that bring higher margins to them than CHX, which means the exchange is not the first, second or third choice in many instances for where their owners want to send equities order flow. To solve that issue, CHX has found a new ownership group and engineered a pending sale.

It is not a sale to CHX’s Chicago neighbor, the CME Group, which stand firmly committed to staying out of the equity trading business. Instead, the sale involves a Chinese led group, the Chongqing Casin Enterprise Group.

CHX’s current owners are a minority-owned group that includes E*Trade Financial Corp., Bank of America Corp., Goldman Sachs Group Inc. and JPMorgan Chase & Co., according to a Bloomberg story published when the sale was announced.

Some of the planned sale has attracted political attention in a highly charged election year environment. Its ownership sale to a new group that includes a minority investment from a Chinese company popped up in a Republican U.S. presidential election debate several times earlier this year.  Of course it was misconstrued and misunderstood by Donald Trump, according to CHX executives.

CHX is seeking to build a business that will include bringing Chinese companies’ listings and capital to the U.S. This is not jobs leaving the U.S., but jobs created here. It is using the U.S. regulatory structure to trade Chinese companies’ shares and using U.S. accounting standards to bring credibility to these companies’ enterprises.

Part of their listing push will be aimed at small to mid-sized firms in the U.S. who seek the regulatory relief of the Jobs Act. Instead of having to be a $1 billion company or more and list on the NYSE, or use crowdfunding at the other end of the spectrum, firms will be able to list on the CHX for more reasonable terms and attract more capital, a very American idea.

With about 80 employees, CHX looks more like the companies that it seeks to list than its bigger competitors. In fact, CHX is the ”last free standing stock exchange” in the U.S., said CHX CEO John Kerin, a 28-year veteran of the exchange.  All the rest are part of bigger companies. And the dark pools and the broker-dealers with trading venues are also part of bigger companies.

CHX seeks to attract more trading too with its SNAP auctions, which are up and running already, and with a new time-delayed auction process similar to that offered by IEX. However, the CHX LTAD, or “liquidity trading access delay,” is in the rule filing stage.

The LTAD is a software-created speedbump, rather than a physical magic shoebox like IEX’s. This innovation is aimed at diminishing latency arbitrage, tightening markets and improving liquidity. It gives market-makers time to refresh their quotes when prices are changing and not get picked off by market participants playing a speed game.

Under the 144-page proposed rule filing for LTAD, market-makers will get 350 microseconds to refresh their quotes. With much of CHX’s current trading tied to futures market trading – its Spiders versus the CME Group’s E-Mini S&Ps – the trigger for price changes is a change in futures prices.

CHX’s arbitrage-related liquidity in Spiders is related to its proximity to the CME Group’s matching engine, as both CHX and the matching engine are located in Northern Illinois.

And CHX’s proposal is for the market-makers to refresh their prices, not for the exchange to recalculate the midpoint as IEX has.

As with any regulatory filing, CHX has its work cut out for it to get LTAD approved by the SEC. Meanwhile, the Committee on Foreign Investment in the United States, or CFIUS, also needs to weigh in on the pending sale. CIFIUS is an inter-agency committee of the United States Government that reviews the national security implications of foreign investments in U.S. companies or operations.

The CHX’s SNAP auction volume has not been as robust as they hoped for, but that could change too with new owners and related order flow. The SNAP auction is for larger block-sized trades of 20,000 shares or $250,000 in value. The SNAP is a half-second auction, give or take 20 microseconds to prevent gaming and information leakage.

The SNAP auctions have five sources of liquidity starting with the initiating aggressive order. The second source is orders in the exchange’s trading match engine, or book, that want to remain active. The third source is from algorithmic traders who want to respond. The fourth source is from an “auction only” book of orders that sits outside the match engine. And lastly, CHX will sponge up liquidity from protected quotes actionable at other exchanges in the NBBO, or National Best Bid or Offer.

The SNAP auctions are aimed at CHX’s institutional clients and algorithmic traders. The auction allocation is in a strict price time format.

The priority for getting CHX’s filing and sale approved will probably come after this year’s presidential election. If all goes well, getting approved then will be a snap and CHX will have new owners and lots of potential new customers.

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Lothian is executive chairman of John J. Lothian & Co. and editor of the John Lothian Newsletter. He publishes MarketsWiki.com, MarketsReformWiki.com, MarketsWikiEducation.com, JohnLothianNews.com and several industry newsletters.