(Updates to add comment from Noll two paragraphs below “Bigger Prints” subheadline.)
Oct. 28 (Bloomberg) -- An exchange owned by Nasdaq OMX Group Inc. asked for permission to introduce a type of order for stocks that must last for a tenth of a second, 10 times longer than some of those placed by the fastest traders.
The Nasdaq OMX PSX market is seeking to attract volume with the orders, which would earn anyone using them a higher payment from the exchange. Equity venues employ a variety of strategies including rebates to spur market makers and trading firms to provide orders at the best prices nationally.
Nasdaq OMX PSX made the proposal as regulators study the impact of high-speed automated trading on the ability of investors to get the prices and transactions they want. Exchanges, traders and government officials have examined whether orders that remain accessible for as long as a second would assure investors that they can trade with the prices they see on their screens.
“This could start the debate” among exchanges about whether orders should have a minimum life before they can be canceled, Joseph Saluzzi, partner and co-head of equity trading at Themis Trading LLC, said in a phone interview. “If they hold this up as a model for the future and encourage other market centers to follow their path, that’s good.”
Saluzzi’s Chatham, New Jersey-based company has advocated requiring exchanges to make orders available for one second for almost three years. He said a tenth of a second may be more appropriate now because of increased speed and automation. Saluzzi said he doesn’t think the Securities and Exchange Commission is likely to take the step of requiring this type of change across all markets. PSX proposal requires SEC approval to go into effect.
The SEC is considering whether to urge exchanges to impose a fee on member firms when their orders exceed a ratio to executions, or for sending messages, which include quotes, updates, cancellations and executions, David Shillman, associate director at the regulator’s division of trading and markets, said at a conference in New York on Sept. 21. Higher message traffic imposes a cost on brokerages, he said.
Nasdaq OMX PSX is one of three stock exchanges run by New York-based Nasdaq OMX, accounting for about 1 percent of U.S. equities volume, according to data compiled by Bats Global Markets in Lenexa, Kansas. The three exchanges combined account for more than 21 percent of U.S. equities volume.
The PSX exchange told the SEC it plans to give a 26-cent rebate per 100 shares to those using the so-called minimum life order, two cents more than the basic payment. Orders that trade against bids and offers already placed on the exchange are subject to a 27-cent fee per 100 shares for their executions.
“The degree to which displayed orders reflect committed trading sentiment has become less predictable, because many entered orders are rapidly canceled,” Nasdaq OMX PSX wrote in its proposal. “Market participants that seek to interact with orders that are canceled before they can execute may ultimately achieve less favorable executions than would have been the case if the order had not canceled or if they had directed their own order elsewhere.”
Senator Charles Schumer, a Democrat from New York, advocated a “minimum quote duration” in a letter to SEC Chairman Mary Schapiro dated Sept. 7, 2010. In January of that year the commission asked market participants whether requiring a minimum one-second duration for orders would benefit investors.
Thomas Peterffy, chairman, president and chief executive of Interactive Brokers Group Inc., based in Greenwich, Connecticut, told the SEC in June 2010 that exchanges should pause investors’ orders for a tenth of a second before trying to match them against bids and offers. That would curtail activity by certain faster trading firms that impair the ability of market makers to profit from supplying public quotes, he said. Bids and offers from market makers shouldn’t be paused, he said.
Market makers and automated trading firms have protested that they need to cancel or update orders rapidly to manage their risk in a high-speed marketplace. Ensuring they’re not accepting undue risk enables them to post bids to buy at higher prices and offers to sell at lower levels, which benefits investors by giving them better prices, they say.
“Market participants are more willing to enter aggressive orders if they can cancel or adjust them in the event that market conditions change,” Suhas Daftuar, a managing director at Hudson River Trading LLC, wrote in a letter to the SEC on April 30, 2010. The firm is a quantitative trading company in New York. “The ability to adjust or cancel orders leads to lower spreads,” he added, referring to the difference between the best bid and offer prices available nationally.
Daftuar said exchanges should be free to test new processes and ways to trade that may benefit investors, including a minimum duration for orders. If such a program succeeds, other venues may copy the initiative, he told the SEC.
Nasdaq OMX PSX, which uses the exchange license of the former Philadelphia Stock Exchange that Nasdaq OMX bought for $652 million in 2008, has been employed to test ideas or trading rules by the parent company. When the venue was reintroduced last year, it implemented price-size priority to execute orders, unlike other exchanges. Instead of matching incoming orders with bids or offers based on who was the first at a given price, called price-time priority, PSX distributes them proportionally to firms based on the number of shares they want to trade.
The aim of the price-size system is to attract larger orders to PSX since those traders would get a bigger share of arriving orders. It also undercuts the emphasis on speed elsewhere, including on Nasdaq Stock Market.
“This order type is for our broker-dealers and their customers who may choose to interact with greater displayed liquidity in a stable quote environment on PSX, which complements our price-time exchanges and improves the quality of our markets,” Eric Noll, executive vice president for transaction services at Nasdaq OMX, said in a statement. “We will monitor customer adoption and use to see if this order type has additional applications on our other equity platforms.”
Jamie Selway, managing director at New York-based Investment Technology Group Inc., said that “people have been talking about minimum order life to throw some sand in the gears of high frequency trading.” While PSX users may adopt the order type, the initiative is likely to have a “fairly minimal” impact on what other stock exchanges do because it wouldn’t be mandated, he said in a phone interview.
PSX’s initiative to encourage market participants to forgo the flexibility of canceling orders as quickly as they want in exchange for an “economic benefit” is in line with other experiments aimed at providing incentives based on behavior, Selway said. Credit Suisse Group AG’s U.S. venue called Light Pool has rules aimed at attracting long-term investors and making the market less appealing for high-frequency or other short-term traders, he said.
The PSX plan won’t help unless it’s imposed on all exchanges, Saluzzi said. It may also hurt investors if brokers route orders to PSX to get a higher rebate, enabling trading firms to take advantage of the buy or sell requests, he said. Brokers send orders to different markets based on the advertised price and factors including the available shares, fees or rebates, and the likelihood of getting an execution, subject to the requirement that they seek the best overall result.
“PSX is their testing ground,” Saluzzi said about Nasdaq OMX’s experimentation effort. “If they’re really serious, put it on Nasdaq.”
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