SIFMA Market Structure Report: Brokers Wait for Clarifications on Block Trades as July 9 Reg NMS Implementation Approaches

Broker dealers are waiting for regulators to clarify certain issues in advance of the July 9 Reg NMS implementation date, according to a panel at the Securities Industry and Financial Markets Association (SIFMA) Market Structure conference last Friday.

The majority of the unresolved issues are around the block trade exemptions, when to time the trade and print to the tape and sweep and what to do with the residual that is left over, said Christopher Concannon, EVP Transaction Services at a href=https://www.nasdaq.com target="_blank">The Nasdaq Stock Market. There are also questions about self-help procedures as well as certain order types such as intermarket sweep orders or ISOs.Although market centers - including exchanges and ECNs - have been live since March 5, the deadline for broker dealers to comply with Regulation NMS known as the Pilot Stock for 250 stocks is only two months away. "So it was much easier for the exchanges than the brokers," says Concannon.

In order to comply with Reg NMS, broker dealers executing a block trade - 10,000 shares or higher - must first take out all the displayed quotes at the top of book of most exchanges.

Prior to Reg NMS, the top-of-book prices were not protected, explains a sell-side trader who spoke anonymously and was not on the panel. For example, today, if the market is 50-to-51 and a client wants to buy stock at 53, "I could trade that stock without regard to what Aunt Millie was trading at 52," says the trader.

However, the world changes on July 9th. Then, the broker has an obligation to send out an ISO to all the protected quotes so that Aunt Millie's quote) is not violated," the trader explains. Brokers will need to have good technology to do that, says the trader.

On the SIFMA Reg NMS panel sell-side trading experts said, there is still confusion over how to determine of the time of the block trade and when the broker has to send out these ISOs. The firms are looking for clarification from the SEC, NASD and NYSE as to what is the time of trade, when they put the block up and what they need to protect.

Larry Leibowitz, managing director, COO Equities at UBS, said the time of the trade is "When you agree with a customer on the phone as to price and quantity." But then, how long does it take you to get to the market and take out the (protected quotes)?" he asks. "We do trades today outside the market. The key for us is to document that trade just as we document a stop today or splitting shares on the New York," Leibowitz says.

Until these issues are clarified by the SEC, NASD and NYSE Regulation, firms are relying on their own interpretations. "The clock starts ticking when you and the client agree to do the trade," says the sell-side trader who spoke anonymously. "The time of the trade is when two clients say done," says the trader. "We have to clock the tickets," he says. Almost simultaneously the trader has to take a snapshot of the market and send out the ISOs. "Then I have 90 seconds to report that trade to the tape," he explains, although he may only wait five seconds until the ISOs come back to print the trade, he notes.

Meanwhile, Brandon Becker, partner and co-chair of WilmerHale's Securities Department, who moderated the Reg NMS panel - and who is a former director of the SEC's Division of Market Regulation - noted that "letters are floating around about handling ISOs," referring to some regulatory action on checking that firms are in compliance with Reg NMS.

In response, Robert Colby, deputy director of the SEC's Division of Market Regulation, said, "It was a letter to one firm about an extreme outlier in ISOs," said Colby. However, the panel didn't elaborate on which SRO sent the letter, or which firm received it.

The industry is also waiting for FAQs from the SEC and possible exemptions related to exchange traded funds, short sales and how to handle preferred securities so as not to violate Reg NMS, said Matthew Lavicka, managing director in the equities division at Goldman Sachs, who currently serves as chairman of the SIFMA Reg NMS Implementation Committee. ETFs are a derivative and primary prices are done in derivative markets, he noted.

Sell-side traders are also still trying to reconcile compliance with Reg NMS with their best execution obligation. "Best execution sets a higher standard than OPR (Order Protection Rule)," said Andrew Madoff, director of proprietary trading at Bernard L. Madoff Investment Securities LLC, who is currently chairman of SIFMA's Trading Committee. "If all you did when you received a large order was send to protected quotes on most exchange top-of-books and trade through the depth-of-books," certainly that wouldn't be best execution, said Madoff. That is why many broker dealers have invested in smart order routing systems to walk down the books and look for liquidity in the depth of books, he suggested. This continues to require "additional costs and additional technology work and gives us more rope to hand ourselves if we mess up," said Madoff.

Given some of these uncertainties, UBS's Leibowitz said firms "better have policies and procedures in place and documentation. He also said "most trading and sweeps can't be done manually. "It's a recognition in today's market you better have automation and policies and procedures in place," emphasized Leibowitz.

In looking ahead to the broker compliance deadline, Nasdaq's Concannon felt "It was fairly dangerous" to move ahead with the exchange implementation of Reg NMS without having an industry-wide test. "We failed to have an industry-wide test of Reg NMS," said Concannon. We should never make that mistake again," he said.

Concannon said he thought it's a great idea to work on an industry wide test for the brokers, but indicated he was worried about the timetable, which includes a Russell rebalancing in June.

Lavicka said, "The July 9 date is really affecting OTC trading and it's all going on in the broker dealers and we need interpretations and FAQs from NASD." While the FAQs are expected in May, then the industry has a Russell index rebalancing and right around the corner is July 9th. "The concern is that firms are going to have additional work," he said.

But Lavicka added, the March 5 implementation was a much bigger big bang event since ITS (Intermarket Trading System) was going away. With the July date, broker-dealers should be going live throughout July, he said. "There shouldn't have a big bang. Most people are phasing in various pieces of it as we speak," added Lavicka. 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