Another ECN is applying for exchange status–this time twice. Direct Edge, following a similar move by competitor BATS Trading, plans to apply to the Securities and Exchange Commission to become an exchange. But it will apply for two separate exchange licenses.
“We plan to file shortly,” said William O’Brien, CEO of Direct Edge ECN. He told Traders Magazine the exchange applications would likely be submitted within the next two or three months. To run an exchange, a market center must be a self-regulatory organization. This appears to be the first time a prospective exchange will file simultaneously for two separate SRO licenses.
The move toward exchange status was not unexpected. When Knight Capital Group, which owned Direct Edge, sold equity investments in the ECN to Citadel Derivatives Group and Goldman Sachs last summer, and subsequently spun off the ECN into an independent consortium-owned company, market participants expected Direct Edge to make a move toward gaining exchange standing.
Direct Edge executives said last year that the ECN might become an exchange by partnering with or acquiring a registered exchange. But that plan recently changed as the ECN saw BATS’s exchange application move through the registration process.
“We’ve been watching the BATS application closely,” O’Brien said. “We commend them on the progress they’ve made to this point. It’s been significant and will only facilitate our own applications.” BATS is an 11-broker consortium-owned ECN that rapidly became the third-largest U.S. equity market. In November, it submitted its exchange application to the SEC, which the Commission published for public comment last month.
For its part, Direct Edge ECN wants two SRO licenses in order to replicate its existing arrangement of dual market models, an offering that has fueled Direct Edge’s recent volume growth, according to O’Brien. The market center currently has two separate price-time priority markets with different pricing models.
Almost half of Direct Edge’s matched February volume was in Nasdaq-listed names, representing 5.2 percent of consolidated volume in Nasdaq-listed securities. Overall, Direct Edge’s matched market share in NMS securities was 3.5 percent last month, up from 3.2 percent in January.
The pricing schedules of Direct Edge’s two markets, known as EDGX and EDGA, appeal to different types of market participants. O’Brien describes EDGX, which offers a high rebate for liquidity providers and has a take fee for those removing liquidity, as an “ECN classic” model that attracts rebate seekers. The other market, EDGA, is free to provide and take liquidity for most players, and appeals to “cost-sensitive removers of liquidity,” O’Brien said.
According to O’Brien, “there is precedent for that [dual model in an exchange environment], given developments in the last few years.” He points out that both NYSE Euronext and Nasdaq OMX Group will soon have three SRO licenses each as a result of acquisitions.
The Direct Edge exec said the trading rules of its two anticipated exchanges “will be virtually if not totally identical, with the main differentiating factor being pricing.” He added that Direct Edge has had an “ongoing dialogue” with the SEC about the registration process.
Direct Edge may soon consider new “strategic investors or partners,” O’Brien noted. The SEC limits any individual broker-dealer member of an exchange from owning more than 20 percent of the exchange, although short-term exemptions to that rule may be permitted.
