‘Trade-Through’ Opens Market-Structure Dialogue

Terry Flanagan

This week’s inaugural meeting of the U.S. Securities and Exchange Commission’s Market Structure Advisory Committee will focus on Rule 611 of Regulation NMS, known as the Order Protection Rule or ‘Trade-Through’ Rule.

It’s a logical starting point for examining the landscape of U.S. equity market structure, according to panelists at last week’s Sifma Equity Market Structure Conference.

“Rule 611 touches on so many things that it’s a great starting point for discussion on market structure,” said Jamil Nazarali, senior managing director and head of Citadel Execution Securities. “It is a starting point for a number of issues including discussing locked and crossed markets, and access fees.”

Rule 611 requires trading centers to have policies and procedures designed to prevent trade-throughs, i.e. trades at prices that are inferior to displayed and immediately accessible quotations at other trading centers.

Nazarali, a member of the SEC committee, said it’s a good vehicle for airing the sentiments of market participants. “I think what we can expect from the committee is a lot of informed and spirited discussion on market structure issues,” he said. “It’s going to serve a valuable purpose in that it’s going to accelerate the ability for the SEC to understand the industry’s viewpoint on many issues.”

Jamil Nazarali, Citadel Securities

Jamil Nazarali, Citadel Securities

Matthew Lavicka, director of equities and chief operating officer of shares trading at Goldman Sachs, noted a dichotomy in the SEC’s attitude regarding the order protection rule.

“On the one hand, the market structure advisory committee is going to talk about the order of protection rule and the impact it’s had,” he said. “On the other hand, they just came out with a tick pilot with a trade-at provision, which is an order protection rule on steroids because not only are you saying that you can’t trade through, but you have to trade at.”

BlackRock, in position papers, has said that scope of the trade-through rule in Regulation NMS should be reduced to only offer protected quote status to trading venues meeting a minimum market-share threshold.

BlackRock also supports a review of exchange access fees because it believes that existing pricing models significantly influence the order handling and routing practices of broker-dealers. Any examination should consider the impact of all related economics and incentives for providing or accessing liquidity such as access fee caps, maker-taker/taker-maker models, and payment for order flow.

“With the order protection rule, what concerns us is that this will potentially encourage and really subsidize an overly high degree of fragmentation in the market,” said Hubert DeJesus, co-head of market structure and electronic trading at BlackRock, at the Sifma conference. “We are concerned about venues that provide marginal liquidity to the market being subsidized by both this particular rule as well as market access fees.”

The issue of access fees has a bearing on the question of whether to lift the current ban on locked markets, which occur when there are multiple marketplaces trading the same security and a bid (offer) on one marketplace is posted at the same price as an offer (bid) on another marketplace. Had both orders been entered onto the same marketplace the bid and the offer would have matched and a trade would have been executed.

Advocates of maintaining the ban on locked markets say that allowing locked markets would result in an increase in crossed markets, where bids on one exchange are at a higher price than offers on another exchange.

“The problem with [allowing] locked markets is that if we go to zero bid-ask size, we’re going to create this public perception where there’s buyers and sellers that are interested in transacting at exactly the same price but no trade is actually occurring,” said DeJesus. “Obviously, the spread in this scenario is not exactly zero, because when you actually take into account the access fees it’s actually a slightly wider spread, but it’s hidden from the public on that level. You can’t go to removing locked markets restrictions unless you also address access fees at the same time.”

Featured image by travnikovstudio/Dollar Photo Club

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