Even before flash orders produced a hailstorm of controversy in Congress and the media, institutional broker-dealers were avoiding these order types.
"We don’t flash," said Dan Mathisson, head of the Advanced Execution Services group at Credit Suisse. "The whole reason we exist is to try to execute [institutional orders] while leaking the smallest possible amount of information. Flashing orders is not consistent with that overall strategy." Credit Suisse said it does not send routable orders from its AES unit to market centers, and therefore doesn’t use flash orders.
Greg Tusar, head of U.S. electronic transaction at Goldman Sachs Execution & Clearing, said his firm does not use flash orders from any of the four venues that offer them. "We don’t use them in the execution of client orders," Tusar said. "But we believe it should be a matter of choice–that clients should have access to them if they choose to. They should be available on an opt-in basis, client by client."
"Flash orders have the potential to cause information leakage," said Jatin Suryawanshi, head of global quantitative strategies at Jefferies & Company. "It’s information that was not available on a data feed that’s now available on a data feed." He added that the use of flash orders, if it’s not done purposefully to aggressively take liquidity, may fly in the face of a broker’s best-execution duties.
Flash orders are marketable orders about to be routed by a market center to a venue quoting at the best price. (Cancellable flash orders seek liquidity or price improvement in that particular market center and are not routed out if there’s no response.) Information about the order is flashed to a group of broker-dealers or displayed on a proprietary data feed available to anyone who receives the feed, typically for less than 30 milliseconds. Firms that want to step up and execute that order at the industry’s best price or better can respond to the flashes.
Suryawanshi noted that those benefiting the most from flash orders are the exchanges and ECNs offering them, "because they’re getting more done within their boundaries." If those orders aren’t flashed, they would be routed elsewhere for execution.
The discussion about whether flash orders should continue to be allowed, and whether they raise regulatory concerns by creating a system in which some market participants can access information about flashed orders that others cannot see, has led to speculation that the Securities and Exchange Commission could eventually nix these order types. The SEC is already looking at broader issues involving the potential impact of non-displayed liquidity on market quality and price discovery.
Now, the SEC has roped flash orders into that review. "This review includes looking into flash orders by exchanges and automatic trading systems that disseminate information to select market participants, potentially disadvantaging other investors," SEC spokesman John Nester told Traders Magazine last week. "The SEC staff is specifically examining flash orders to ensure best execution and fair access to information for all investors."
Flash orders gained industry attention in the lead-up to their introduction in June by Nasdaq and BATS Exchange. Direct Edge and the CBOE Stock Exchange already offered order types that seek to keep marketable orders in-house by enabling broker-dealers to match or improve the best price available on another market. Ten days ago, following a spate of media criticism of flash orders, Senator Charles Schumer sent a letter to SEC Chairman Mary Schapiro, exhorting her to pull the plug on these order types.
In June Direct Edge’s Enhanced Liquidity Provider (flash) program accounted for 1.45 percentage points of the ECN’s matched market share of 11.89 percent. BATS’s June market share was 10.72 percent, with 1.25 points coming from its BOLT, or flash, executions. Nasdaq did not release information about how much its flash executions contributed to its June market share. July figures are not yet available.
William O’Brien, Direct Edge’s CEO, noted that the potential benefits of flash order types for customers is price improvement and size improvement. He said his ECN’s ELP program, which is optional for participants, is used by a mix of retail and institutional brokerages. He declined to say how much price or size improvement ELP executions receive on average. Direct Edge is owned by a consortium that includes the International Securities Exchange and four broker-dealers. BATS Global Markets, which runs BATS Exchange, is owned by 11 broker-dealers.
TD Ameritrade is one of many retail brokerages that use flash orders. Retail brokers typically have smaller-size orders that are less likely to suffer slippage than block-size institutional orders being worked in the market through algorithms or direct-market-access tools.
Christopher Nagy, head of order routing, sales and strategy at the retail brokerage giant, noted that although "seeds of doubt have been cast in retail minds," TD Ameritrade sees clear benefits from using flash orders. "We view our obligation to protect clients by getting them the best possible prices in the market very, very seriously," he said. "We have seen and continue to see excellent results for our clients using flash orders."
TD Ameritrade looks at slippage, price improvement and price disimprovement statistics to gauge execution quality with flash orders. "We see flash orders getting dynamic pricing at the inside [market]," Nagy said. He added that customers whose flash orders get executed may also avoid the potential time delay in routing the order to another market center and possibly missing that quote. His firm has used Direct Edge’s ELP program since 2006.
For brokers working institutional orders, however, flash orders raise leakage concerns. Jamie Selway, managing director at White Cap Trading, an institutional agency broker, said his firm doesn’t use flash orders to execute orders. While he believes these order types conflict with the existing requirement for a market center to display its best quotes and should not be permitted by regulators, he thinks they should be an option for customers that might want to use them for as long as they are allowed by the SEC.
In a letter emailed to customers this morning, Bob Gasser, chief executive of agency broker ITG Inc., told clients his firm wasn’t using flash orders on any market centers. "ITG does not engage in ‘flash’ order activity on behalf of our clients," Gasser wrote. "We prefer to control order execution much more precisely by directly accessing the quotes displayed by each market."
Jefferies’ Suryawanshi raised another issue for institutions. Buyside firms, he suggested, should take care to avoid unwittingly having their orders flashed when using DMA tools. "Straight DMA orders are now getting risky because there’s a lot visible on feeds that wasn’t visible before," he said. Suryawanshi added that using an immediate-or-cancel order "to dig through hidden liquidity" is no longer effective in all markets. "If 1,000 shares of a stock are displayed and the trader sends an IOC order for 5,000 shares that gets flashed, the residual 4,000 could now be exposed on the data feed," he said.
At the same time, while many brokers don’t flash orders, they do feed flash message information into their smart order routers to improve executions for their institutional customers. Mathisson of Credit Suisse said his firm’s smart order router reads the flash orders on Nasdaq’s and BATS’s proprietary feeds. "That feeds into our heat maps," he said. "We may not directly respond to flashed orders, but for the allotted time, which is some milliseconds, that destination would be heavily weighted [if we have an order on the opposite side of the flashed order]."
Mathisson calls flash orders a step backward in market structure. "They electronically recreate the crappy aspects of the old floor system," he said. "Flash, the Direct Edge ELP program and the parity system on the New York Stock Exchange create a privileged class that gets free options or can cut the line–and that’s not fair."
The reference to cutting the line involves the ability of broker-dealers, including Credit Suisse, that see flash orders to cut in front of existing limit orders by responding to flash orders. Flashed messages enable smart order routers executing a broker’s client order in that name, on the opposite side, to route an order to that market to capture the spread. The firm could therefore buy at the bid or sell at the offer without waiting on line to get that execution, which it would have to do if it hadn’t seen the flash messages and was seeking executions by putting limit orders in the market.
