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December 2, 2013

Fragmentation Stirs Ire

By By Peter Chapman

Industry professionals took the opportunity to gripe about the proliferation of stock exchanges at this year's Security Industry and Financial Markets Association market structure conference.

There are now 13 stock exchanges. Brokers get steamed because of the cost of connecting to the platforms and the complexity they bring to trading. "I actually think we're going to see more venues," said Sapna Patel, head of market structure and liquidity strategy at Morgan Stanley. "We won't see much consolidation."

Patel maintains that the Securities and Exchange Commission's Order Protection Rule, which requires brokers to trade against the marketplace's best quote no matter where it is posted, keeps small bourses in business. It also encourages the start-up of new exchanges, she said.

Five stock exchanges each trade no more than 1 percent of total industry volume, on average, according to data from BATS Global Markets. They are the Chicago Stock Exchange, Nasdaq PSX, the National Stock Exchange, the CBOE Stock Exchange and NYSE MKT.

Citadel Securities senior managing director Jamil Nazarali, speaking at the SIFMA conference, echoed Patel, blaming the Order Protection Rule for propping up tiny exchanges. "They trade less than 1 percent of the daily volume," Nazarali told the audience. "That imposes a cost on the rest of the industry because you have to connect to them and take in a price feed. Maybe that's not justified. Maybe we need to revisit the idea of a protected quote."

That could be in the cards. "There may be a couple of potential proposals floating around out there that may actually reduce the incentive for more exchanges," Brett Redfearn, head of market structure strategy for the Americas at J.P. Morgan Securities, said at the SIFMA confab. New regulations requiring exchanges to distribute quotes within a minimum time frame-say five milliseconds-could become part of the Order Protection Rule, Redfearn indicated. If an exchange can't distribute a quote fast enough, then it wouldn't be protected.

"If it lagged too long, should it be protected?" Redfearn asked. Driving any such rule change is a desire to ensure the integrity of the consolidated quote, Redfearn explained. Only those quotes that meet the minimum would be counted in the official bid or offer.


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