The following is taken from an edited podcast between SIFMA’s Ken Bentsen and Ellen Greene
“The global pandemic COVID-19 has caused extreme shocks to our economy and financial markets. A symbol of these unprecedented times, on March 23, the New York Stock Exchange closed its physical floor and moved to fully electronic trading.
Ken Bentsen, SIFMA president and CEO, sat down with Ellen Greene, SIFMA’s Managing Director of Equity and Options Market Structure and Katie Kolchin, CFA and Director of SIFMA Research, walk us through an analysis by SIFMA Insights to find out whether the closure of NYSE’s physical floor has impacted its market share.
Edited for clarity
Ken Bentsen: I’m Ken Bentsen, president and CEO of SIFMA. Welcome to this episode of The SIFMA Podcast.
The global pandemic COVID-19 has caused extreme shocks to our economy and financial markets. U.S. equities closed the first quarter with their worst performance since the financial crisis. We’ve lived a lifetime in just a few short weeks – it was just mid-March when firms started to initiate business continuity plans and market pressures started to manifest themselves. A symbol of these unprecedented times, on March 23, the New York Stock Exchange closed its physical floor and moved to fully electronic trading.
Today, we’re here to discuss the findings of a recent report by SIFMA Insights that asked, what does this all mean? I’m joined by Ellen Greene, SIFMA’s Managing Director of Equity and Options Market Structure, and Katie Kolchin, CFA, SIFMA’s Director of Research.
Ellen, it surprises some people to learn that U.S. equity trading is not quite 100% electronic today.
Ellen Greene: That’s right, Ken. To date, there are 13 U.S. equities exchanges and, by year-end, three new exchanges are expected to go live. While no longer a material portion of equity trading, we estimate the application of human touch in equity trading is approximately 1%-2% of market volume.
When we look at the current equity exchange landscape, we see that there are currently four exchange families: Nasdaq with three exchanges, all electronic; Cboe Global Markets with four exchanges, also electronic (which were acquired during the BATS acquisition in 2017); IEX with one license, one SRO, also electronic; but then, we look at the New York Stock Exchange, which is unique.
NYSE is the largest exchange both by number of equity exchanges as well as market share. While NYSE’s exchanges are all electronic, it runs a hybrid model of electronic and human interaction in two of its five exchanges. NYSE balances technology along with DDMMs or Designated Market Makers, and floor brokers on its two hybrid exchanges. The human element can be critically important at the open and the close, with mostly electronic trading intraday. However, there are certain events, including the opening and closing auctions, IPOs and secondaries, which blend technology and human judgment.
Ken: The NYSE has had specialists operating on its floor since 1872. Since migrating to a hybrid model, the specialists have been replaced on the NYSE floor with the Designated Market Maker (or DMM) model, which still enables a fair and orderly market for their assigned securities. DMMs operate manually and electronically – a hybrid model, as Ellen pointed out – to facilitate price discovery during market opens, closes and periods of trading imbalances or instability by maintaining depth of book in the securities they trade. The NYSE also has floor brokers, acting in an agency-only capacity. Ellen – can you tell us why they chose to maintain this human presence?
Ellen: Sure. At all times during the trading day, it is critical that prices reflect current market interest. The closing auction has evolved into a significant daily liquidity event in an otherwise fragmented equity market structure. Today, approximately six percent of NYSE listed volume occurs during the auction. The close is an indication of the current value of a stock and the closing price is critical since it is used to set daily Net Asset Values (NAVs) for indexes, mutual funds and ETFs. The NYSE believes the hybrid model provides price transparency, enhances efficiencies, and ensures smooth functioning of its closing auction.
As far as the details are concerned, New York offers several order types, including D orders, for its closing auction which allow investors of all types to participate while receiving a fair and accessible price. NYSE believes its hybrid structure with electronic and manual traders results in lower volatility, deeper liquidity and price improvement for investors.
Ken: Beginning on March 23, in order to protect the health of employees on the floor and not contribute to the strain on the New York City health care system, Intercontinental Exchange (ICE), the parent company of the NYSE, temporarily closed its equities and options trading floors and began electronic trading only. How does the closing of the physical floor and the move to an all-electronic model affect the closing auction?
Ellen: Naturally, electronic order flow continues as normal since it was already electronic – and this comprises the overwhelming majority of the New York’s volume.
As Katie will discuss, the NYSE trades approximately ten percent of its total number of shares in NYSE-listed companies with most of its activity occurring during the closing auction.
While DMMs continue to have electronic responses to auctions, the prior manual DMM processes used an exchange execution process, range-bound by price collars, to fill imbalance orders (our understanding is that typically all imbalance orders were filled either through the DMM or otherwise). With the floor closure and no manual DMM or floor broker processes, NYSE is using an electronic-facilitated auction, which also uses price range boundaries. However, our understanding is that there are now more market and limit-on-close orders left unfilled which get canceled back to the buyer or seller, who is typically an institutional customer. When the floor is open, floor brokers start disseminating imbalance information at 2:00pm versus 3:50pm in an electronic mode. Also, in floor mode, the exchange can publish imbalances after 4:00pm to bring liquidity in to manually facilitate a closing auction, which cannot happen today. Floor brokers represent around 5% of intraday flow and 33% of open/close auctions. The D Orders, a unique selling point of NYSE’s closing auction, are not available under the floor closure. Instead, investors must use electronic market- and limit-on-close orders, which are offset with electronic imbalance orders. Floor brokers can still connect to NYSE electronically, but there is no open outcry at the close.
I do want to stress though, Ken, that structurally, operations have functioned well since the floor closure.
Ken: Katie, you recently published a report that compared movements in market shares across parent exchange groups, individual exchange licenses and on- versus off-exchange trading volumes. What did you find?
Katie Kolchin: Thank you, Ken. Before we begin, just a quick note on our process in the report: we analyzed movements in market shares across parent exchange groups, individual exchange licenses and on- versus off-exchange trading volumes from the start of the year, January 2, through the end of April. We note that market shares can fluctuate based on day, month or time period chosen. Therefore, the period available to us for analysis and at this point in time may be too short to be indicative of any long-term market share shifts.
In general, the analysis showed that, prior to the early Easter close week, there was an upward sloping trajectory for NYSE’s aggregated market share, or market share across all of its exchange licenses, from January to that week. Numbers worsened in April, but we do not view this as significant. NYSE’s market share is down 1.6 pps, but the numbers fluctuate weekly throughout the time period and other exchanges have also seen periods of declines (and also swings) throughout the same time period. However, based on the downward trend at the end of the time period analyzed, we do believe we must wait and see if there will be long-term impacts on NYSE’s market share.
Ken: The market turmoil we’ve seen in the past several weeks is evidenced by sharp price declines – yet spikes in volumes – in equities markets which, as we said, closed the first quarter with their worst performance since the financial crisis. Let’s dig in on volumes and volatility – an entire topic on which we have another discussion that I commend to our listeners, entitled The VIX and the Virus.
Katie: It has indeed been volatile. Equity ADV peaked at 19.4 billion shares on February 28, which is +150% from the start of the year; historically, we trade about 7 billion shares per day in equities in the U.S. April ADV remained elevated at 13.1 billion shares (April 29), +70% from the start of the year.
On the other side, the VIX, or the fear gauge which is an indicator of what markets expect for volatility in a 30-day forward-looking period, peaked at 82.69 on March 16, +563% from the start of the year; it remained elevated in April averaging 31.23, which is still +150% from the January 2 start of the year.
Ken: And what about on versus off-exchange trading?
Katie: In general, during periods of high volatility, more volumes move onto exchange trading in order for traders and investors to participate in price discovery (improve transparency essentially). During low volatility times, more volumes move off-exchange. What we saw was that more volumes did indeed move on-exchange as volatility spiked in the first quarter – on average, 63.4% of volumes in March were on-exchange vs. 60.1% in January – but this has normalized since the VIX came back down. The trendline for on-exchange trading is now downward sloping for the year, albeit with a modest slope. April’s average was 58.4% for on-exchange trading.
Ken: Now that we found out how on exchange volumes moved throughout the time period, can you walk us through your analysis across exchange groups?
Katie: I’ll set the scene with just general market landscape for 1Q20 for the parent companies. NYSE held the highest market share at 24.3%; followed by Nasdaq at 18.6%, Cboe at 16.7% and IEX at 2.6%.
Looking at just the NYSE market share movements, NYSE looked like it had been gaining share from January to March, with an upward sloping trendline from the start of the year. March average market share was 24.4%, versus 23.5% in January. Again and as I said earlier, the shift and prior to the early Easter close week around April 6, this reversed over that long weekend and that trendline is now downward sloping for the year, with April average market share 22.1%.
Looking just around the period of the initial floor closure, the Monday before the close, before any noise about the close, NYSE’s market share was 24.6%, and was up at 26.7% that Friday. On the following Monday, on March 23 when the floor officially closed, it fell to 22.6% and it was at 20.7% on April 29, again this is 1.6 pps down from the start of the year.
Essentially, prior to the early close week, we would have concluded the floor closure had not significantly impacted NYSE’s market share. Now, based on the downward turn at the end of this time series, the end of April, we must wait and see if there will be long-term impacts on NYSE’s market share.
Looking at the market share movements across all of the exchanges though – where others have experienced declines and swings in up and down periods – we found that it does not appear any other particular parent exchange group is out-and-out winning. It is also not a significant enough loss of share at NYSE to declare that this will be a permanent shift.
Ken: So, as you said, the period available to us for analysis was short and may not be indicative of any long-term market share shifts.
Katie: That’s right – it’s wait and see. Things could change. But as Ellen said, structurally, NYSE operations and all the exchanges have functioned well since the floor closure. Albeit, we are seeing some institutional orders remain unfilled at the close at the NYSE with the floor closing. Only time will tell us if investors feel the difference in execution of their trades with or without the human interaction on the floor and whether their sentiment sustainably impacts NYSE market share.
Ken: The report from SIFMA Insights, which includes a good deal of data and in-depth analysis of market share movements within individual exchange parent group’s complexes, is available on our website, www.sifma.org. There, you can also find relevant primers on equity market structure and learn more about SIFMA and our work to promote effective and resilient capital markets.
Ellen and Katie, thank you very much for joining us.
Ellen/Katie: Thank you.