With U.S. stock exchanges continuing to launch new equity trading platforms to capture more order flow (and thus, dollars), the number of equity market centers has jumped over the past nine months, causing some industry participants, who cite the complexity and fragmentation of the equity market structure, to question whether there are too many trading venues. There are now 12 stock exchanges and at least 45 dark pools in the U.S. that match equity buy and sell orders.
This year, four new stock exchange licenses were activated. Direct Edge won approval for two new exchange licenses, for EDGA and
EDGX,which previously were electronic communications networks (ECNs). Nasdaq OMX launched the Nasdaq PSX on Oct. 8. And BATS Global Markets, the third largest exchange operator, launched its second stock exchange, the BATS BYX Exchange, on Oct. 15; the BATS (BZX) Exchange, which initially launched as an ECN, went live as an exchange in August 2008.
The issue has become so contentious that institutional agency brokerage firm Themis Trading in Chatham, N.J., called for a moratorium on approvals by regulators of new market centers and alternative trading systems (ATSs) until the SEC has determined the cause of the May 6 Flash Crash. [Ed. note: The SEC and CFTC issued in October a joint report on the Flash Crash. "Any time they come out with a new exchange, it's [said to be] innovative and with a new fee structure," says Sal Arnuk, partner and cofounder of Themis Trading. But, "What's 'innovative' about the new exchange architecture? It's a catchall phrase."
Chasing the Money
Arnuk maintains that while these so-called innovations are customer-driven, they are not at the request of long-term investors such as pension funds. Rather, exchanges are introducing the new market models to cater to high-frequency traders, which happen to trade hundreds of millions of shares a day, he argues. "They're following the money and trying to please those customers," insists Arnuk. But, "Those needs aren't always congruent with the needs of [long-term] investors," he adds, noting that Themis' 30 institutional clients overwhelmingly support the firm's calls for a halt on new stock exchange approvals.
The trend behind the formation of new stock exchanges was started by the two primary markets, NYSE Euronext and Nasdaq OMX Group, which run multiple market models and matching engines. NYSE Euronext operates NYSE Classic, NYSE Arca and NYSE Amex, while Nasdaq has three exchanges -- Nasdaq Classic, Nasdaq BX and the new PSX exchange.
In the wake of the Flash Crash, however, some industry participants are concerned about the fragmentation of liquidity across so many venues, which often have unique rule sets. While one exchange executive who requested anonymity says he doesn't believe the fragmented venues caused the May 6 event, he admits that there are too many venues with insignificant market share, creating cost burdens for the industry. "It costs the brokers money to connect to the new venues, and it's more risk they take on," he asserts.
Steve Wunsch, a market structure consultant who helped invent and launch the ISE Stock Exchange and the Arizona Stock Exchange, also has called for a moratorium on new exchange licenses in comment letters to the SEC, citing flaws in the market structure that he says the SEC created via Reg NMS. In an opinion piece, Wunsch argued that some of the electronic venues are clones of each other. Under Reg NMS, he continued, these clones were allowed to disengage from the New York Stock Exchange and continue trading after the NYSE's Liquidity Replenishment Points were triggered on May 6, exacerbating the market meltdown.
"Apparently, coordinating the clones is a tougher task than was first thought," Wunsch wrote, pointing out that the top four markets operate 10 exchanges. "And the clones are still multiplying."
Since all of these exchanges are electronic and interconnected, any glitch in one can be amplified throughout the market, Wunsch notes in an exclusive interview with Advanced Trading. "The more exchanges you have there, the more nodes you put into the routing complex, the more things you cause to break down," he cautions, adding that the fragmentation and interconnectivity allow practices such as "high-frequency trading and malicious processes to burgeon." Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio