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2021 | OriginalPaper | Buchkapitel

4. Coping with the Dynamics of a Continuous Market

verfasst von : Amber Anand, Amy Edwards, Vijay Kedia, Dmitry Bulkin, Richard Carleton, Philip Pearson, Robert Shapiro

Erschienen in: Equity Trading Round-Up

Verlag: Springer International Publishing

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Abstract

ROBERT SCHWARTZ: Our next moderator, Amber Anand, is now based a long way from New York City — in Syracuse, upstate New York, to be precise. My goodness, he’s practically in the snow belt these days!

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Vorheriges Kapitel The View from Here

Nächstes Kapitel Strengthening the Infrastructure

In a competitive program to encourage trading on exchanges, maker-taker fees offer a transaction rebate to trading participants who provide liquidity, and charge customers who take liquidity.

A lit exchange or market refers to venues that display the various bids and offers in stocks. By contrast, dark markets, or dark pools, do not display prices.

Chapter 3: Luncheon Address: The View from Here

Kevin Cowan, President, TSX Markets and Group Head of Equities, TMX Group.

In a follow-up note, Richard Carleton explained that the Canadian Securities Exchange (CSE) also provides a continuous auction market for stocks listed on other Canadian exchanges. In the USA, these are the “Unlisted Trading Privileges” sanctioned by regulators to provide competition in execution services, while aiming to ensure the integrity of “better priced orders” being executed.

In a follow-up, Carleton explained that the USA and Canada both have rules limiting the incentive a market can pay a liquidity provider, that is the “maker” in the maker-taker model, to 30 mils per share. “The issue is that, at the time of this discussion, the typical US equity share was $50/share US while Canada was in the $20/share range,” Carleton noted. “On a value basis, the liquidity provider is being paid a lot more in Canada than in the US.”

Benchmark 60 index. https://us.spindices.com/indices/equity/sp-tsx-60-index

In a follow-up, Carleton explained that the maker-taker model “stimulated”—indeed, it “probably overstimulated”—trading in large cap names in Canada and was not successful in increasing or improving market quality in the mid- and small-cap portions of the market.

In a follow-up, Carleton noted that the “aggressive” side of the order at the time of the conference, or the liquidity “taker,” was almost an agency order.

“This meant that discount brokers and other firms that handle primarily agency orders were seeing their costs escalate because the clients typically enter marketable orders into the system,” he added. “They don’t have a balance of ‘maker’ orders and ‘taken’ orders.”

See, footnote 3.

Carleton was describing dark pools operated by most of the bulge-bracket dealers in the USA.

This is a source of controversy. It is widely believed, but never publicly confirmed, that a number of the large Canadian-based bank brokers sought to reduce their costs by selling their retail flow to US wholesalers, through the US subsidiaries of these same Canadian-based bank brokers.

“In this way, they could avoid payment of ‘take’ fees to Canadian exchanges, and instead earn fees from the sale of the orders to the US wholesalers. Payment for order flow is not a permitted practice under Canadian securities laws,” according to Carleton in a follow-up.

Ibid.

In a follow-up interview, Anand explained that he was speaking in the context of the maker-taker model and of incentives for posting and taking liquidity. He was questioning whether natural marker responses to buying and selling stocks as an intermediary — that is to say, reduce rebates when there are a growing number of intermediaries — would be viable, and result in desired outcomes. In fact, he envisages that such an approach would reduce liquidity.

In a follow-up, Phil Pearson noted that traders use “inverted venues to ‘cut the queue’ because cost-sensitive smart order routers target inverted venues first.” As he further elaborated, to trade passively in stocks with large queues at the primary exchange, “the only way to do so is by posting on a different exchange.”

An inverted venue refers to an exchange that offers two models to lure more equity trading volume, the conventional maker-taker model and a taker-maker model, or inverted rebate system where the liquidity taker is paid for handling a trade. Examples of exchanges offering inverted rebates have included Nasdaq BX, Bats BYX, and Bats EDGA.

Reg NMS (Regulation National Market System) was adopted by the Securities and Exchange Commission in 2005 and introduced 2 years later to further advance the ideals of a national market system. The regulation includes the order protection, or trade-through rule; access rule (fair access) to market data including quotations; rules on sub-penny trading and on market data.

This refers to the ability of market participants to gain advantages in the speed of their trade executions and price-quote data through advanced technology, specifically by the “co-location” of their computer servers near stock exchanges’ computers. That lowers so-called latency, a critical factor in high-speed trade executions. The practice is regarded as legal though it has many critics.

A method of determining the effectiveness of a company’s portfolio transactions. Transaction cost analysis (TCA) is essentially a rating of the spread between two possible prices – and the difference between those prices is often called “slippage.”

Source: ft.com/lexicon

For an extensive study on the debate between SIP versus Direct Feeds, See, SIP vs. Direct Feeds Latency—What are the Rules? Bloomberg Tradebook, May 15, 2014 https://www.bloomberg.com/professional/blog/sip-vs-direct-feeds-latency-rules/

Does the ‘Make-Take’ Structure Dominate the Traditional Structure?—Evidence from the Options Markets

A Anand, J Hua, T McCormick Management Science 62 (11), 3271-3290. 2016

Can Brokers Have It all? On the Relationship between Maker Taker Fees and Limit Order Execution Quality. Robert Battalio, Shane A. Corwin, Robert Jennings. Journal of Finance. May 23, 2016. Volume 71, Issue 5.

As Bulkin explained in a follow-up interview, conflicts of interest would be eliminated if all US exchanges were mandated to set the same pricing structure for executions, with or without rebates for order flow. As the system is currently structured, market participants will base their order executions decisions on the economics and incentives offered by prices and rebates, Bulkin argues.

As Bulkin remarked in a follow-up interview, mandated prices across US exchanges is problematic in a capitalistic economic system.

See update, Exchanges’ Fees and Rebates Could Get a Cut

SEC proposes test on trading without system of incentives that have been criticized. Dave Michaels. Wall Street Journal. March 14, 2018 https://www.wsj.com/articles/exchanges-fees-and-rebates-could-get-a-cut-1521042510

Zero refers to the idea of executions that are effectively free, and only cost “zero.”

Referring to the maker-taker model. Anand explained in a follow-up that with “asymmetry” – that is to say, a different price for posting liquidity than the price for taking liquidity - there is an incentive for market participants. “If both sides have to pay, say 3 cents for 100 shares, then there is no incentive to be on one side or the other of the trade,” he said.

Referring to the proposed pilot program for trading small-cap stocks in wider minimum increments. The pilot eventually was approved by the Securities and Exchange Commission. See, SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies. Center for Financial Stability, May 7, 2015. http://centerforfinancialstability.org/wp/?p=5987

This tick-size pilot program, October 2016 through October 2018, defined Securities eligible for participation in the tick-size pilot program as having a market cap of $5 billion or below.

The tick-size pilot included stocks with a market capitalization of up to $5 billion, and volume of up to 1 million shares per day. After public comment the market capitalization threshold was changed to $3 billion.

The tick-size pilot was an experiment that examined whether a 5 cent tick is more appropriate than a 1 cent tick.

Referring to the baseline spreads with a 1 penny tick.

This is to say, “using a threshold metric that is not likely to be impacted by the pilot program,” Amy Edwards elaborated in a follow-up note.

In a follow-up, Amy Edwards explained: “The pilot can have both positive and negative effects across a number of metrics. Therefore, it is not possible to specify one rule that would clearly indicate that a 5 cent tick size is better than a 1 cent tick size.”

“Prior probability, in Bayesian statistical inference, is the probability of an event before new data is collected. This is the best rational assessment of the probability of an outcome based on the current knowledge before an experiment is performed.” Source: Investopedia

Regulation SHO. https://www.sec.gov/spotlight/shopilot.htm

Stratified sampling is a process of sampling from a population in a systematic manner to ensure a representative sample.

The tick size is the minimum dollar increment for prices in a market. In the equity market, the tick size determines the quoting increment. The bid and offer quotation prices must be specified in tick sizes. However, traded prices are not restricted to tick increments.

A somewhat tongue-in-cheek comment, presumably referring to the idea that technological complexity is self-perpetuating, creating business opportunities for technology vendors.

For a more complete understanding of the technology referenced here go to the FlexTrade website: https://flextrade.com/

Ibid.

See, footnote 25.

SECURITIES AND EXCHANGE COMMISSION

(Release No. 34 -72460) June 24, 2014. Order Directing the Exchanges and the Financial Industry Regulatory Authority To Submit a Tick Size Pilot Plan.

https://www.sec.gov/rules/other/2014/34-72460.pdf

In a follow-up, Phil Pearson explained that he was suggesting that when there is no set criteria to determine success/failure of a project or pilot, “regulatory bodies may be willing to find statistics that validate their theories rather than view the data objectively,” so as to prove “the experiment” was worthwhile and not just a waste of time.

In a follow-up, Richard Carleton explained that in an effort to ensure all listed stocks have a market maker prepared to commit to providing a two-sided market, “with agreed order size and spread maintenance goals, the CSE was looking at a system that would permit the listed company to pay the market maker a fixed amount per month.”

In a follow-up, Carleton explained that the leadership of these companies were not typically financial markets experts, but were otherwise talented professionals. “We found that it was extremely helpful to these people to provide training in market structure, fund raising and presentation skills,” he added.

Referring to the OTC QB and OTC QX boards operated by the OTC Markets Group in the USA.

“For the issuer, the benefit of having a quotation on a regulated market in the USA is that their potential shareholder audience has increased by a factor of [between] 10 to 13,” Carleton explained in a follow-up, comparing the smaller Canadian market with the much larger US market. ”We also see that activity in the US comes back to the Canadian market,” he added. “The market makers will cover short positions in Canada, flatten long positions and line the Canadian book with orders to protect against sudden market moves. All of this improves market quality in Canada.”

IEX Group. https://iextrading.com/about/

Raymond (Ray) L. Killian, Jr. was the former president and CEO of Investment Technology Group (ITG) and one of the company’s original founder.

Liquidnet. http://www.liquidnet.com/

See, footnote 14.

The issuers would pay some specific sum to exchanges, or in some instances, directly to market makers, to incentizise them to generate more liquidity in the trading of their company stocks.

In a follow-up, Amy Edwards noted that exchange-issuer pay programs were available for a subset of ETFs in the USA. NASDAQ, ARCA, and BATS had these programs but had no subscribers at the time of the conference. Later, on this same panel, Steven Poser of the New York Stock Exchange, noted that the NYSE had one ETF listed on the issuer-pay model.

Many exchanges in Europe utilize designated market makers (DMMs) to supplement and provide liquidity, especially in mid- and to small-caps. In the USA, DMMs, formerly known as specialists on the New York Stock Exchange, are responsible for providing fair and orderly markets in their assigned stocks.

A Liquidity Program to Stabilize Equity Markets, Journal of Portfolio Management, August, 2014. Nazli Sila Alan, Fairfield University, John S Mask, Deutsche Börse AG, Robert A. Schwartz Baruch College—CUNY https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2495819

See, Flash Boys: A Wall Street Revolt. Michael Lewis (2015, WW Norton & Company, LLC).

Referring to the idea that large buy-side institutions are in a better position than smaller institutions to run their own “experimentations” in terms of incentives and executions, according to Anand in a follow-up.

Referring to the idea that an algorithm will break down a large order, say for 100,000 shares, and called the “parent order,” into smaller orders, known as “suborders” or “child orders,” say of 5000.

Garbage In, Garbage Out: An Optical Tour of the Role of Strategy in Venue Analysis. Ian Domowitz, Krsti Reitnauer, Colleen Ruane. ITG. 26 August, 2016

http://www.itg.com/marketing/ITG_WP_Domowitz_Reitnauer_Ruane_20140825.pdf

In a follow-up, Philip Pearson noted that this was referring to the same concept as previously described. “By understanding all of the different ways venues are accessed, including the entire routing decision-making process, different order types, etc., venue (data) evaluation can take place using more rigorous approaches,” he said.

See, footnote 16.

In the process of being implemented as of writing, 2018. www.catnmsplan.com

Enhancing Our Equity Market Structure.

SEC Chair Mary Jo White.

Sandler O’Neill & Partners, L.P. Global Exchange and Brokerage Conference New York, N.Y. June 5, 2014. https://www.sec.gov/news/speech/2014-spch060514mjw

Actionable in this context is referring broadly to the idea of the data being useful in the trading process.

See, footnote 16.

EMS is an Electronic Management System; OMS is an Order Management System.

Anand, A., P. Irvine, A. Puckett, and K. Venkataraman. 2012. Performance of institutional trading desks: An analysis of persistence in trading costs. Review of Financial Studies 25:557–98

SECURITIES AND EXCHANGE COMMISSION (Release No. 34-72692; File No. SR-BATS-2014-022) July 28, 2014 Self-Regulatory Organizations; BATS Exchange, Inc.; Order Granting Approval of a Proposed Rule Change to Amend the Competitive Liquidity Provider Program On June 3, 2014, BATS Exchange, Inc. (“Exchange” or “BATS”) filed www.sec.gov/rules/sro/bats/2014/34-72692.pdf

See, footnote 14.

Zicklin School of Business Annual

Financial Markets Conference, Baruch College, Market Integrity: Do Our Equity Markets Pass the Test?

Equity Trading in the Fast Lane: The Staccato Alternative

Robert A. Schwartz and Liuren Wu

The Journal of Portfolio Management Spring 2013, 39 (3) 3-6; DOI: https://doi.org/10.3905/jpm.2013.39.3.003

See, Limit Up, Limit Down. www.luldplan.com

In a follow-up, Carleton explained that he was saying that “paying a market maker would not, on its own, have all of the desired market quality improvements without also being supported by an aggressive communications programme.”

Carleton is speaking metaphorically, employing the British and Canadian term for political campaigning.

Anand, A., Tanggaard, C., and D. Weaver, “Paying for market quality.” Journal of Financial and Quantitative Analysis, 44 (2009), No. 6, 1427-1457

Titel: Coping with the Dynamics of a Continuous Market
verfasst von: Amber Anand
Amy Edwards
Vijay Kedia
Dmitry Bulkin
Richard Carleton
Philip Pearson
Robert Shapiro
Verlag: Springer International Publishing
Buch: Equity Trading Round-Up
Print ISBN: 978-3-030-51014-5

Electronic ISBN: 978-3-030-51015-2

Copyright-Jahr: 2021
DOI: https://doi.org/10.1007/978-3-030-51015-2_4