US Equity Market Prepares For New Orders and Exchanges

The US Securities and Exchange Commission has approved the proposed Discretionary Limit, or D-Limit, order type from exchange operator IEX Group as three new exchanges are also slated to launch within the next month.

IEX said the purpose of the D-Limit order type is to protect liquidity providers from potential adverse selection resulting from latency arbitrage trading strategies, and to encourage members to submit more displayed limit orders to the exchange.

Alexander Gerko, founder of XTX Markets, the quantitative-driven electronic market-maker, tweeted it was the “biggest news in US equity market microstructure since Reg NMS. Well done @IEX for persevering and getting it done.”

The SEC said in its ruling that D-Limit orders will not impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act.

“The D-Limit order type is IEX’s competitive response to mitigate current competitive imbalances between liquidity providers and latency arbitrage liquidity takers,” added the SEC. “It is designed to encourage market participants to post more priced limit orders, including displayed orders, on IEX, and thereby promotes just and equitable principles of trade, removes impediments to and perfects the mechanism of a free and open market and a national market, and, in general, protects investors and the public interest.”

In May Better Markets supported the new order type in a comment letter  to the SEC. The non-profit, non-partisan organization which promotes the public interest in the financial markets said the D-Limit type protects investors against predatory latency arbitrage trading strategies and helps increase liquidity as the current market structure allows investors’ order to be traded at stale prices.

“We believe that if the D-Limit Order type is approved as proposed, it should help IEX to protect liquidity providers—and by extension, investors—from fast predatory trading firms that take advantage of market participants due to stale prices of securities,” wrote Better Markets.

In March a group of buy-side firms wrote a letter to the SEC in support of the new order type as IEX would be promoting displayed orders without simply offering a greater rebate or unfair option to select market participants.

“We believe it will diminish the effect of latency arbitrage, encourage the provision of displayed liquidity without introducing significant unintended consequences, improve the current trading environment and foster a more liquid and stable market across the board’,” said the letter. “In a trading environment that has increasingly gone dark, we believe the new order type proposed by IEX is a timely and badly needed innovation that goes to the heart of the market forces that have caused this shift and has market participants increasingly avoiding trading “out loud” (therefore weakening the price discovery function of the markets). “

Periodic auctions

In another new order type for the US market, Cboe Global Markets is waiting for SEC approval to launch periodic auctions after success in Europe with the mechanism. Periodic auctions last for very short periods of time during the trading day and are triggered by market participants, rather than the venue, helping them find liquidity quickly with low market impact, while prioritizing size and price.

Adam Inzirillo, head of US equities at Cboe Global Markets, told Markets Media last month: “In the last couple of years, as off-exchange trading volumes have grown, periodic auctions give the public an on-exchange alternative for executing block trades and attracting natural interest.”

The US model will be different by including randomization of the auction message, having no broker preference and allowing displayed orders to become part of the auction. In the European Union, exchange operators may own dark and lit books, but the current US regulatory regime precludes Cboe from owning and/or operating an ATS. Therefore Cboe intends to introduce periodic auctions on its Cboe BYX Equities Exchange.

Inzirillo said: “Periodic auctions also address some of the issues raised by the SEC regarding illiquid securities, which a high percentage occurs off exchange.”

Jim Toes, chief executive of the Security Traders Association, said in a webinar hosted by Greenwich Associates yesterday that auctions could be an interesting mechanism.

Toes said: “Auctions provide a unique function and are really good for trading thinly traded securities with minimal market impact as they focus liquidity.”

New venues

Shane Swanson, senior analyst for Greenwich Associates market structure and technology, and Toes discussed the three new exchanges that are due to launch in the next month.

The Long-Term Stock Exchange (LTSE) is due to go live on August 28; Members Exchange (MEMX) on September 4 and MIAX PEARL Equities on September 25.

Toes said  LTSE has an interesting model which is built on listing standards rather than transaction revenues while MEMX is owned by investors who believe that trading is too expnesive on current exchanges.

He continued: ‘The top third of securities trade very well while the bottom third have liquidity challenges. We need a solution for the middle third.”