Structural changes that have arisen as a result of dark pools and ATSs are at the heart of the holistic review of equity market structure that the Securities and Exchange Commission has stated it will undertake this year.

A fundamental premise of the national market system is that market participants should have the opportunity to participate in a market at least when it reaches a significant size.

“Fair access is a very important market structure issue,” said Jamil Nazarali, head of Citadel Execution Services. “More and more volume is moving off exchange. Today, 40% of volume trades off exchange, and that volume has been growing dramatically. Exchanges have fair access rules, so anyone can trade on the exchange. The same is not true for dark pools.”

Regulation ATS exempted from exchange regulation those trading systems that were operated as broker-dealers, did not act as self-regulators, and did not hold themselves out as exchanges. In the place of exchange regulation,
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Regulation ATS originally required ATSs to establish fair access procedures when they reached a 20% market share threshold. The SEC as part of the Regulation NMS adoption process reduced the threshold for application of the ATS fair access requirements from a 20% to a 5% market share.

“Although ATS dark pools do have fair access rules, the reality is that most are still able to decide who they want to allow on their platform because they limit their volume to stay below the fair access thresholds,” Nazarali said. “Non-ATS dark pools have no fair access rules at all. We think that’s unfair, because with 40% of the volume trading off exchange, if someone can’t access that 40%, they’re going to be severely disadvantaged. We think it’s important for the SEC to revisit its fair access rules as more trading moves off-exchange.”

In reviewing today’s market structure, the SEC will need to address unintended consequences of past regulations.

“While well intentioned and often beneficial to the markets, previous regulatory changes have contributed to fragmented liquidity, a large amount of opaque trading in dark pools and internalizers, and an overly complex market place,” said the Modern Markets Initiative, in a blog posting. “All of these challenges to the market are important to consider and must be addressed.”

The Modern Markets Initiative is an advocacy effort organized by quantitative trading firms, including Global Trading Systems, Hudson River Trading, Quantlab Financial, and Tower Research Capital.

To address these challenges, regulators must understand them and characterize them appropriately. “The role of dark pools and internalizers needs to be debated,” said the Modern Markets Initiative, in a blog posting. “In fact, one of the real issues regulators face with dark pools is that they operate under much less stringent rules and regulations than exchanges.”

Citadel Securities for the first time has disclosed volume data for its IOC (Immediate or Cancel) gateway, Citadel Connect. A record 72 million equity shares traded through Citadel Connect on average per day in January, up from 25 million shares per day a year earlier.

“Citadel is the largest retail market maker in the U.S.,” said Nazarali. “Historically, our focus has been on the retail business. Over the past year and a half, we have expanded our market making business beyond retail.”

Citadel Connect offers market participants minimal transaction costs, high fulfillment rates, and low market impact, while providing executions in over 7,500 exchange-listed securities, according to the company.

“Citadel Connect enables us to make markets for institutional traders,” Nazarali said. “It allows firms to interact with our market maker. It’s not just an off-exchange cross of liquidity. As a market maker, we stand ready to buy and sell, and we allow institutional customers to send an immediate or cancel order (IOC).”