The amendment the New York Stock Exchange filed this week to its hybrid market plan isn't likely to put any of the difficult issues it faces to rest. But in providing detailed examples of how its hybrid market will work, the NYSE appears to have laid the foundation for meaningful debate.
The New York Stock Exchange filed the 83-page amendment to the Securities and Exchange Commission. (It can be accessed at www.nyse.com/pdfs/2004-05amend2.pdf.) This marks the second amendment the NYSE has filed to its hybrid proposal, which is an ambitious attempt to automate equity trading while preserving the strengths of specialists and floor brokers who conduct the human-agency auction market.
The big difference between the two previous filings is that the exchange is filling in pieces of the puzzle by providing specific rules and examples, says Jamie Selway, managing director of Whitecap Trading LLC, an institutional brokerage firm that is a customer of the NYSE. Selway -- who analyzed the filing for institutional clients -- notes it provides an appendix with 27 trading examples explaining the new operations.
NYSE made its original SEC filing in February to sketch out the NYSE's proposal to expand Direct+, its automatic order-execution service, and it amended that in August. Major stakeholders who submitted comment letters, including firms such as Fidelity Investments, said those documents didn't provide enough detail into the complex operational workings of the hybrid markets new rules. Selway says the trading community is most concerned about three top issues: Liquidity Replenishment Points (LRPs), which are price thresholds at which auto-execution stops; the broker agency interest file; and the specialist interest file algorithm. In this filing the NYSE addresses all of those issues to some extent.
First, it defined the Momentum Liquidity Replenishment Point (MLRP) for the first time. The MLRP will essentially suspend the auto-execution feature when a stock moves either 25 cents, or makes a 1 percent price movement, over a 30 second period of time, says a NYSE spokesperson. That suspends auto-ex for 10 seconds in one transaction, the spokesperson adds.
Second, the NYSE gives specifics on how the broker interest file works, which is a type of reserve book for floor brokers, says Selway. Under hybrid trading, floor brokers would use an agency interest file to electronically represent liquidity, he says. What's new is that the broker would have discretion whether their aggregate shares in the file are going to be disclosed to the specialist, says the NYSE spokesperson. Previously, they automatically were disclosed, and under the new play the floor brokers could determine whether they will be disclosed, says the spokesperson. If the broker decides not to disclose and the broker ends up as the best bid or offer, at least a thousand shares would be disclosed, says the spokesperson.
Selway says the NYSE is giving the floor broker the option of keeping some of the order hidden, which gives the floor broker more discretion. "Originally there was concern over who can see this order. Can the specialist see the order? Who else in the crowd can see the order?" Selway says. For example, if the floor broker has 10,000 shares sold on behalf of customers, and the broker's offer becomes the best quote, the broker could show 1,000 with 9,000 in reserve or some combination in between, says Selway.
Third, the new filing elaborates on the specialist interest algorithm and gives detail on what specialists can and cannot do. These algorithms automate the specialist activity. "Essentially, the algorithms use market data and information about incoming orders to populate the Specialist Interest File," writes Selway in a commentary e-mailed to clients. Today, specialists update quotes manually, while tomorrow they will have the ability to update quotes automatically via an API, says Selway. For example, if a specialist wants to match another market that has a better price, they can do that.
Selway says this is an improvement over the existing environment. If the exchange automates specific behaviors and "front-loads clear cut rules into the software -- as opposed to the specialist looking at incoming orders and using that information to make conditional decisions in a given to five-to-10-second period -- it's a much cleaner environment," says Selway.
There are other clarifications in the filing. The NYSE's filing clarifies how the specialists would interact with the InterMarket Trading System (ITS) when there is a better price at another marketplace such as INET or Archipelago. Selway says there was a lot of misinterpretation of how they would operate with the ITS and trade-through rule. Now the filing says the NYSE is going to automate the ability for the specialist to match the better price and if the specialist doesn't match, they're going to route it out to protect the away market's quote. "As long as the NYSE is automating its protection of Arca, and as long as it's matching the best price, it's a good improvement," says Selway, who previously was the chief economist at Archipelago and worked at Nasdaq as well.
The NYSE also defined a crowd -- that was something that wasn't determined before, says the spokesperson. A crowd would consist of five consecutive panels at a single post. Each stock is traded at one specific spot on the trading floor, and that spot is called a panel. A specialist could trade several stocks at that panel, or a broker could be in a crowd up to five panels away and still be considered part of that crowd.
The filing will be published by the SEC for a 35-day comment period. Selway says people will still argue NYSE is a monopoly system, and that while specialists aren't needed, he says the exchange has done a "pretty good job in taking some major steps and addressing the major criticisms" raised by commentators. Though he expects a "contentious" comment period, Selway predicts approval from the SEC could come in the first quarter of next year.
After SEC approval, the NYSE will need nine to 12 months to implement the hybrid market. From a practical aspect, someone has to build the system. While the limit-order books and Direct+ exist, there's nothing like the specialist algorithm file. 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