Direct Edge Holdings, an ECN operator, last week took a big step toward achieving exchange status for its two markets.
The Securities and Exchange Commission on Friday published Direct Edge Holdings’ applications for two exchange licenses. William O’Brien, CEO of Direct Edge, told Traders Magazine last month that his firm expected to receive exchange approval for EDGX Exchange and EDGA Exchange by the end of the year. He said the two exchanges would be operational "shortly after that."
Direct Edge operates the third-largest market for U.S. equities. In August, it transacted a monthly record of 12.9 percent of the industry’s volume.
Hanging over Direct Edge’s future, however, is the prospect of regulatory action that could affect the market’s "enhanced liquidity providers" program, which has drawn volume to Direct Edge over the last couple of years. Although the program has been operational since 2006, it gained attention this past summer as NYSE Euronext and others criticized it for enabling some firms to respond to marketable orders before the rest of the market got wind of those orders.
The occasion for the criticism was Nasdaq OMX Group and BATS Exchange offering "flash" order types on their markets, starting in July. Those orders had a similar function to Direct Edge’s ELP program, although they operated in different ways.
Following a storm of controversy, Nasdaq OMX and BATS withdrew their flash-like orders. The CBOE Stock Exchange and Direct Edge’s markets retained their flash functionality. SEC Chairman Mary Schapiro, however, said last month she had asked her staff to come up with a proposal "to eliminate the inequity that results from flash orders." Market participants expect that the SEC to address this issue within a week.
O’Brien this morning called the SEC’s publication of Direct Edge’s two exchange applications a "milestone" for Direct Edge. Once the applications are formally published in the Federal Register, there will be a 45-day public comment period. Direct Edge submitted the applications to the SEC in May.
Direct Edge’s application appears to be the first time a firm has submitted applications for a pair of exchange licenses to the SEC. Direct Edge currently has two ECN markets, called EDGX and EDGA, and intends to maintain this dual structure in the exchange world.
Nasdaq OMX Group and NYSE Euronext each own three securities exchange licenses. However, they acquired the licenses when they bought other exchange operators. Nasdaq OMX owns the Philadelphia Stock Exchange and the Boston Stock Exchange. It currently operates two equities markets: Nasdaq Stock Market and Nasdaq OMX BX, the old Boston market.
NYSE Euronext acquired the Pacific Stock Exchange when it bought Archipelago Holdings several years ago. It bought the American Stock Exchange last year. NYSE Arca is the only one of its three exchanges that trades all National Market System securities. The Big Board and Amex trade their own listed names, although Amex, starting early next year, will trade Nasdaq-listed stocks as well.
Operating two markets gives Direct Edge several benefits. It enables the firm to offer different pricing for transactions on each exchange. Different pricing enables Direct Edge to attract different types of customers to each of its markets. In addition, two exchanges gives Direct Edge two protected quotes, which could draw more flow to its markets.
Direct Edge is owned by a consortium that includes the International Securities Exchange and several big broker-dealers. The ISE owns 31.5 percent of the company. Citadel Derivatives Group, the Goldman Sachs Group and Knight Capital Group each own 19.9 percent. The remaining 8.8 percent of the company is owned by J.P. Morgan and four other broker-dealers.
