Trade-At Rule Pits Exchanges Vs. Brokers
Traders Magazine Online News, April 15, 2010
Call it the battle of the seen versus the unseen. The "trade-at" question in the Securities and Exchange Commission concept release pits the public exchanges against brokers who internalize trades and other off board liquidity providers.
Chris Nagy, TD Ameritrade
In its Jan. 13 concept release, the SEC raised several questions about undisplayed liquidity's impact on price discovery. Trade-at is essentially a question regarding order handling and the routing of orders to the best price. It would shift liquidity from internalized sources, such as broker-dealer dark pools or other non-displayed liquidity providers, to the displayed markets.
The trade-at issue is something akin to the time-tested retail strategy of not only matching a competitor's best advertised price, but also beating it--price improvement.
However well that works in the retail consumer industry for TVs, washers and dryers, the subject hasn't captured an enthusiastic endorsement from traders and industry executives.
According to some, the clear beneficiaries of trade-at are the exchanges as their trading flows and fees should increase.
"Questions about market quality aside, this debate is really a market-share grab between brokers and exchanges," said consultant Bill Harts. "The amount of order flow being internalized right now probably isn't large enough to affect price discovery. The SEC is taking a proactive approach by asking, 'What if it ever gets that large?'"
Many believe that the SEC is raising the question of whether or not internalization and dark pools are bad for price discovery, the public markets and investors. Trade-at is not a rule proposal at this time, but one of hundreds of questions the SEC has posed in its concept release to the industry, as it reviews how today's equities markets function.
If trade-at is formally proposed as a rule and passed, it would fall under Section 11A of the Securities Exchange Act of 1934. The SEC describes trading centers as exchanges, ECNs, over-the-counter market makers and dark pools. The SEC asks whether trade-at should affect them all or just some.
For example, such a rule would require "trading centers," including brokers, to route an order to the best price in the market, unless they are holding a limit order at that price. Of course, a trade-at rule would allow a broker to execute an order at a penny better than the national best bid or offer, giving an investor price improvement. But a broker would not be able to execute a client order, or match, the best bid or offer in the marketplace without price-improving.
Spokespeople at BATS Exchange and Direct Edge declined comment. However, both are in the process of submitting comment letters to the SEC. Calls for comment from NYSE Euronext and Nasdaq were unreturned.
Trading executives see no reason for the rule, given that off-board or internalized trading is only 20 percent of total market volume and the remaining 80 percent of trading flows are still done publicly. Prices, they contend, haven't suffered and liquidity has actually been improved, bringing more retail investors into the trading markets and keeping commissions low.
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