More innovation welcomed in US equities

Ray Ross, Co-Director of Electronic Trading at BMO Capital Markets, looks forward to continuing to innovate in the U.S. equity markets this year after launching new venues and order types in 2020.

Ross told Markets Media that there have been a lot of changes in the microstructure of the market over the past few years which has allowed the broker to execute trades faster and with less impact, to the benefit of investors. final.

Ray Ross, BMO Capital Markets

“We have seen a lot of good progress and we are certainly looking forward to seeing what comes next,” he said.

Three exchanges were launched in the United States in September 2020 – Members Exchange (MEMX), MIAX Pearl Equities and Long Term Stock Exchange (LTSE) – bringing the total to 16.

MEMX reported that in April, it had a monthly record 2.2% average daily market share and 214 million shares traded each day. The exchange added that its market share increased 46% in April and became the sixth largest U.S. stock exchange. MIAX Pearl Equities reported executing a total of 452 million shares in April 2012.

Ross said BMO is welcoming new venues and new competitions to the market.

“MEMX has had some success, but it takes a long time for any location to gain critical mass,” he added. “The jury is still out and all new exchanges have a lot of room to develop.”

Another new platform is expected to enter the US stock market this year, subject to regulatory approval. PureStream Trading Technologies aims to launch an alternative trading system that will be the first US equity trading platform that allows institutions to algorithmically trade blocks with orders corresponding to a cash flow, allowing them to trade large transactions with less impact on the market. ATS closed a $ 14 million fundraiser in February 2012 with BMO Financial Group among the investors.

“We are thrilled with the launch of PureStream as it is a very different model of matching client interests based on negotiation rate, rather than price, which is very geared towards blocking institutional interests and resolving a real challenge, ”added Ross. “Today there are two ships in the night each creating an impact, but PureStream enables non-impact exchanges in innovative ways.”

Order types

In addition to the new platforms, more new types of orders are likely in the US stock market this year. The United States Securities and Exchange Commission has approved the introduction of periodic auctions in the United States by Cboe Global Markets. The exchange uses the mechanism in Europe where periodic auctions last for very short periods during the trading day to help market participants find liquidity quickly with low market impact, while prioritizing size and price.

In Europe, Cboe has a separate book dedicated only to periodic auctions, but in the United States, auctions will take place on Cboe BYX Equities Exchange to adhere to Reg NMS rules regarding posted orders. Additionally, in the United States, the message identifying the start of an auction will be randomized to help mitigate any potential adverse selection. Clients can send orders as recurring auctions eligible to trade with the Continuous Book provided that no auction has been initiated, or as recurring auctions only to participate in only one auction.

“The concept of holding auctions, especially for less liquid securities with wider spreads, could be an interesting solution,” said Ross. “We are delighted to see how it goes.”

BMO said in its comment letter to the SEC that the broker would like to see periodic auctions start in the United States as a type of order only mid-term in order to reduce complexity and would like to see the mechanism’s impact on the market. data flow.

“These are nuances and we generally support the type of order,” Ross added.

Consultancy Coalition Greenwich said in a report that Cboe’s proposal for periodic auctions not only aims to improve trading for thinly traded securities, but encompasses all NMS stocks and incorporates BYX’s ongoing book into the auction process. .

“Comments on the proposal were mixed, however, the SEC approved the proposal in an order dated March 26, 2021,” the report said. “The Cboe plans to launch the US version of periodic auctions in the third quarter, and it will be interesting to see what kind of traction it gains in the months to come.”

In October 2020, IEX Exchange fully launched its discretionary limit order type D-Limit, which protects investors from adverse selection after receiving long-awaited SEC approval. The location machine learning signal seeks to predict how the market will move in the next split second. D-Limit then uses the strength of the IEX signal to move an order if the price is about to become imminent, i.e. the order avoids being ‘breached’ when the price is unstable.

BMO used the D limit order and Ross said it protects their quotes from adverse selection and reduces implementation costs for trading.

“We are able to get better quality prints as well as increase the number of high quality prints,” he added. “This means we can trade faster and bring more liquidity to the market. It is therefore an important new tool that solves a real problem. ”

However, Citadel Securities sued the SEC, saying the regulator’s approval was inappropriate and the case is ongoing. In April 2021, the Healthy Markets Association filed an amicus brief in the United States Court of Appeals in support of the SEC, IEX and investors, claiming that the D-Limit order protects investors against predatory transactions.

Off-exchange trading

Ross identified another focus of innovation as the exchanges compete for the flow of orders that left the exchange due to increased retail participation. In the United States, retail transactions are not executed on exchanges, but most are sold by brokers to market makers under ‘payment for order flow’ arrangements, which allows brokers offer commission-free retail transactions. Market makers internalize the flow and capture most of the spread, in exchange for offering retail investors a slight improvement in the exchange price.

Trade Reporting Facilities (TRF) managed by the Nasdaq and NYSE capture over-the-counter transactions, such as in alternative trading systems, internalisers, internal matching through central risk books and single-dealer platforms . Ross added that the volume of TRF is now larger than any single exchange and also larger than any exchange family, so significant liquidity is absent from the exchanges.

“We will continue to see innovation and an increased focus on retail and the use of wholesalers,” he said. “Payment for order flows impacts the quality of execution, so we need to create more market centers where as many participants, and as many types of participants, can come together to trade.”

Ross argued that market makers have an important function to play when a buyer and seller cannot find each other, but in recent years they have been able to negotiate in almost every case, even at the expense of ‘other investors.

“We’re seeing a lot of innovations in order types and venues that allow natural investors to come together without the need for a third-party market maker in the middle,” Ross added. “When natural buyers and sellers come together, the end investor gets better execution quality because adding a third party only makes transactions more expensive.”

Ross said allowing retail and institutional liquidity to rally could lead to significant price improvements for retail investors, who won’t have to pay the full spread, as well as more transactions from institutions, which would improve liquidity for the entire market.

The US House Committee on Financial Services held hearings on retail and order flow payment after shares in retailer GameStop rose 1,600% in January. Online broker Robinhood was forced to temporarily halt trading in GameStop and other ‘hot’ stocks to cover its netting margins, leading to allegations of market manipulation and unfair treatment of retail investors , and could lead to new regulations.

Ross said: “For a long time, innovation was really just a game of costs, but I think the industry has exhausted the number of different price points we can have. The fight for the flow of orders is now progressing upstream and this is positive. “

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