The National Stock Exchange is looking to roll out a new order type that will allow users to bypass quotes posted by two of its largest customers—the LavaFlow and Light Pool ECNs.
The move, disclosed in a filing with the Securities and Exchange Commission, could lead to more trades done on NSX, but put a crimp in the businesses of the two electronic communications networks. It is the second change by the NSX in the past two months to affect the operations of the ECNs, after it imposed a fee for delivering orders in December.
The Jersey City, N.J.-based exchange has been tinkering with its services and pricing since it came under new management at the end of 2011. On December 30, 2011, the NSX was acquired by a competitor, the CBOE Stock Exchange, owned by CBOE Holdings.
Under the NSX’s latest proposal, which must be approved by the Securities and Exchange Commission, the new order type is an immediate-or-cancel order. It would only trade against those quotes subject to automatic executions. It would not trade against the quotes of ECNs, whose executions are subject to delays.
In its filing with the SEC, the NSX, said the new order type would satisfy those traders who don’t want to wait for a response from an ECN. Executives from NSX declined to talk to Traders Magazine for this article.
Currently, only two ECNs operate in the U.S. stock market: Citigroup’s LavaFlow and Credit Suisse’s Light Pool. Both ECNs quote only on the NSX because the exchange is the only venue that operates an order delivery service. Under the service, NSX notifies the ECNs of an incoming order, giving them a fraction of a second to accept or decline the trade.
ECNs need that time to determine whether or not their quote has already traded on their own books. The problem is that an immediate fill on the NSX’s book could leave them with a double execution.
It is this lag the NSX seeks to eliminate for those customers who don’t want to wait. “The proposed Auto-Ex Only order will benefit users by allowing them to interact only with orders entered via auto-ex mode, thereby avoiding the delays associated with interacting with orders entered via order delivery mode,” NSX told the SEC in the filing.
Representatives for the two ECNs would not comment.
The new order type is the second time in the past two months that the NSX has changed its rules to the detriment of the ECNs. In December, the exchange introduced a notification fee payable by those customers who utilize its order delivery service. Now, every time the NSX delivers a notice to an ECN of a pending trade, it charges them 35 cents.
Behind the move was frustration with the ECNs’ trade-to-quote ratio. The ECNs publish a large number of quotes through NSX, but only trade against a small fraction of them. Instead, they use the publicity they receive by quoting on NSX to build a business away from the exchange on their own books, NSX alleged.
In November, the NSX found that the ECNs accounted for 74 percent of the exchange’s message traffic, but only 9 percent of its trading volume. NSX trades about 25 million shares per day.
Because so much of the ECNs’ business is done off-exchange and because the exchange must maintain a costly infrastructure to support its order delivery service, the ECNs had become unprofitable, NSX told the SEC in a filing. It was unable to recoup its investment in the service through transaction fees.
The ECNs were “successfully leveraging the exchange’s infrastructure to develop their business away from the exchange, even as the majority of the exchange’s operational costs are fixed,” the NSX told the SEC.
