Senator Charles Schumer of New York called on the Securities and Exchange Commission today to ban flash orders on Nasdaq, BATS Exchange and Direct Edge. This follows a week in which several financial blogs have taken up the issue of flash orders, questioning whether they are good for the market.
In a letter addressed to SEC Chairman Mary Schapiro, Schumer (Dem.-NY) asked the SEC to "prohibit the use of so-called ‘flash orders’ in connection with optional display periods" permitted by Direct Edge, Nasdaq and BATS. He did not mention the CBOE Stock Exchange’s flash orders.
Schumer told the SEC that if it failed to act, he planned to introduce legislation in the Senate to prohibit the use of flash orders prior to routing out equities orders.
Schumer said flash orders "allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public, allowing those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity." Flash orders are typically delayed for up to 30 milliseconds before being routed onward.
Market centers with flash functionality provide information about routable orders to their participants, recipients of their proprietary data feeds, or firms that participate in certain liquidity-providing programs. The intention is to keep orders in-house by enabling firms to offer liquidity to marketable orders at prices equal to or better than the best price available on another market center. The CBSX and Direct Edge programs have operated for more than a year and a half. Nasdaq and BATS launched their programs in June. Nasdaq’s Boston market, Nasdaq OMX BX, introduced flash orders on Monday.
In June, volume from Direct Edge’s Enhanced Liquidity Provider program contributed 1.45 percentage points to the ECN’s 11.89 percent market share. BATS’s BOLT, or flash, orders accounted for 1.25 percentage points of that exchange’s market share of 10.72 percent.
The New York Times, this afternoon, was first to report that Sen. Schumer had asked the SEC to ban flash orders. The SEC did not immediately respond to a request for comment. Nasdaq, Direct Edge and CBSX also did not respond immediately. BATS and the New York Stock Exchange declined to comment. Schumer’s office could not be reached.
NYSE Euronext and GETCO, one of the largest market makers in a variety of asset classes, criticized flash orders in late May, in response to rule filings submitted to the SEC by Nasdaq and BATS. Nasdaq offered these order types to be competitive with Direct Edge, which has gained market share this year. BATS followed up with similar order types to avoid giving Nasdaq an advantage.
Both NYSE Euronext and GETCO said flash orders create a tiered market in which some participants gain access to order information ahead of others and can act on that information. They also noted that these order types create, effectively, virtual locked markets, which is prohibited by the SEC.
Joe Ratterman, BATS’s CEO, has voiced concern about the impact of these order types on equities market structure even though his exchange rolled out BOLT orders. In a newsletter two weeks ago, he observed that the delay required for flash orders raises questions about whether the venues are offering "immediate" executions.
He also highlighted a handful of issues worthy of "further investigation" by regulators and the industry. In addition to creating a two-tiered market for information, he wrote, flash orders result in "price-forming resting orders" not getting the executions they would in the absence of flash orders, "thereby creating a disincentive to post aggressive limit orders and harming the price discovery process." The presence of flash orders also means that the consolidated tape stream does not reflect the industry’s best prices, he wrote.
Adam Sussman, research director at TABB Group, a financial research and consulting firm, noted that flash orders are part of the ongoing battle for market share in an evolving equities landscape. "Flash orders violate the spirit, if not the letter, of Regulation NMS," he said. "The exchanges want to have their cake and eat it too by deploying this functionality while quietly criticizing it."
