“My gut assessment: There are advocates for both sides on the trade-at rule, but the exchanges that advocated trade-at had a receptive audience at the SEC,” said Steven Glass, president and CEO at Zeno Consulting Group LLC, Washington, a boutique consultant firm that monitors trading issues on behalf of asset owners. “My theory is that to just widen the spreads without the trade-at rule could turn even more people to dark pools. If the SEC is ultimately concerned about the integrity of the markets, they have a strong preference toward transparency — and that means lit exchanges.”
Mr. Glass cited a June speech by Mary Jo White, Securities and Exchange Commission chairwoman, in which she related concerns about both the increased trade flow to dark pools and how to expand the small-cap equity market.
“In my mind, she was already combining the two,” he said. “The first time I saw the SEC formally discuss the trade-at rule was in a 2010 concept release. In that, there was not one reference to small-cap stocks. It's hard to say how transparency and small-cap liquidity were linked.”
Dark pools are protected in the pilot program as proposed; there are exemptions in all test categories for block trades and for trades executed at midpoint, said Jamie Selway, managing director and head of electronic trading at brokerage and financial markets technology provider Investment Technology Group Inc., New York. ITG operates a dark pool.
But if changes were to be made when the pilot program goes live, that would create universal trade-at provisions for all trades, “That would be really bad for institutions,” Mr. Selway said. “That would go against the statutory mandate of the SEC to get best execution.”
Henry Yegerman, director of trading analytics and research at financial data provider Markit Group Ltd., New York, questioned the motivation behind including a trade-at provision in the test. He also voiced concern about its impact on trading costs.
“The real question is, who gets something out of putting the trade-at rule in regulation?” Mr. Yegerman said. “The exchange owners? Well, duh! Who would have thought? Let's assume it's not just self-interest. Who will benefit other than the lit markets? It won't be the market makers. Also, there's an increase in trading cost to find someone that will trade at a half-penny higher. The metric (in the test) may not measure what (the SEC) wants to measure. Price improvement is not the same as lower trading cost. This test will mean better spreads but also more executions, with possibly higher cost.”
NYSE Group officials in a statement said the tick-size pilot program — including the trade-at provision — should broadly benefit investors. “The tick-size pilot will test alternatives for building better quality markets for smaller public companies, and success could come in the form of greater market-maker participation, increased displayed liquidity, improved fill rates and less price volatility,” according to the NYSE statement. “We believe pilots can be a useful source to collect data and analyze market structure changes, and we support the SEC moving forward with other pilots to test alternative market structures for the entire equities market.”
Officials at Nasdaq did not return repeated calls for comment.
Not all of the exchanges that signed off on the tick-size pilot agree the trade-at provision should be included. Said Joe Ratterman, CEO at BATS Global Markets LLC, Kansas City, Mo.: “We resisted (trade-at) at first, but the SEC asked for a plan, and we decided that we would sign off on it even though there were elements in it we didn't believe in.”
BATS will submit its views to the SEC during the comment period, Mr. Ratterman said.
“Trade-at would unnecessarily disrupt the market ecosystem,” Mr. Ratterman said. “From our viewpoint, we advocate what's best for all markets and all investors. Right now, investors can seek a number of venues on which to trade, and dark pools are a great place to find liquidity without causing potential effects on the market. Trade-at would be a regulatory sledgehammer that would take trading options away from the investor.”
BATS does not operate a dark pool but does route some orders on the direction of investors to dark venues.