BATS Trading, the fourth-largest U.S. equities market, has made it through the first big hurdle in its quest to become an exchange. On Wednesday, the Securities and Exchange Commission submitted BATS Exchange’s application to become a registered exchange for public comment, ushering the ECN further down the path of greater regulation.
“We hope to become an exchange this year,” Joe Ratterman, president and CEO of BATS Holdings, told Traders Magazine last month. BATS Exchange filed its exchange proposal in November and amended it this week, based on discussions with SEC staff.
BATS Exchange will operate in a similar fashion to the current BATS ECN. It will be an automated price-time priority market, focused on speed, with no specialists or market makers. BATS Trading will be the exchange’s outbound routing broker-dealer. BATS Holdings, formed last June, is the exchange’s parent company.
BATS’s chief reason to become an exchange is to secure top-of-book protection for itself. Once it’s an exchange, BATS’s best bid and best offer would automatically be protected. Currently, BATS quotes on the International Securities Exchange and National Stock Exchange.
“The primary benefit is to participate directly in the tape system so our quotes get directly disseminated into the NMS and get protected directly,” Ratterman said. As an exchange, BATS would control its own execution systems, including the dissemination of order-book information. That’s seen as necessary in a marketplace that demands extremely low latencies for data and trading. By quoting elsewhere, BATS’s quotes are subject to latencies in those systems and latencies in the process of publishing its quotes in systems other than its own.
“Owning the top of book yourself is critical in a Regulation NMS environment,” says Diego Perfumo, an analyst at Equity Research Desk, an investment advisory firm based in Greenwich, CT. “The ability to get executed depends on the speed of access to the top of book.”
The importance of fast access to protected quotes has driven the biggest exchange groups, with which BATS competes, “to accumulate tops of books” by acquiring other exchanges, according to Perfumo. Nasdaq, for example, bought the Boston and Philadelphia stock exchanges, and NYSE Euronext owns Arca and will soon add the American Stock Exchange to its roster.
For BATS, another benefit to exchange status involves market data revenues. Converting to an exchange would allow BATS to get market data revenues directly from the securities information processors. BATS currently gets a rebate from the ISE and NSX for 50 percent of the quoting revenues its order flow generates. The FINRA/NYSE trade reporting facility rebates BATS 50 percent of the trading revenue its prints generate.
“We’d have more resources to get more aggressive on our pricing if we wanted to,” Ratterman said. “Today we get half of what our activity generates. As an exchange, we’ll get 100 percent of what our activity generates.” BATS’s exchange filing says the firm does not plan to charge participants exchange fees. The only fees participants will pay are those to remove liquidity.
Equity Research Desk’s Perfumo expects BATS to compete with the NYSE, Nasdaq and NYSE Arca based on speed and pricing. But he says there’s a ceiling on the market share BATS is likely to acquire. “There is a segment of the market interested in the BATS offering, but it’s limited,” he says. “It’s stayed around 8 or 9 percent, even with inverted pricing. That segment of fast high-frequency traders will continue to use BATS for the rebates.”
Ten broker-dealers currently have ownership stakes in BATS. These include Citi, Credit Suisse, GETCO and Merrill Lynch. BATS, based in Kansas City, MO, was founded in June 2005 and began trading in January 2006.
