OUT OF ORDER:
Are Controls Needed on Choice, Complexity and Competition?
January 10, 2013
In 2012, BATS introduced a pricing incentive for orders, called NBBO Setter, that was aimed at market makers.
But in this case, it says, the beneficiaries were all investors.
BATS gives “a slightly higher rebate to someone who’s making markets on BATS, and they set the NBBO,” Isaacson said. This encourages market makers to (1) improve the price that’s available to the entire public, and (2) do it on a BATS exchange.
The self-interest of exchanges can come into play. The Nasdaq Stock Market, for instance, has a “price to comply” order type that makes sure any order complies with the SEC’s National Market System rules. But the order type is designed to keep the order on Nasdaq and not end up elsewhere.
That can seem at odds with the rules. “Shouldn’t it really just route to the best bid and offer that is out there? Shouldn’t that be the default?” said the head of trading at a major institutional trading firm, with nearly a trillion dollars under management.
“If we’re going to have a national market system, shouldn’t all these venues be routing to the best bid and offer for the customer’s execution? Why are they pricing it to keep it at that venue?” said the trader, who insisted on anonymity, to keep trading on all venues with all participants.
Nasdaq also has a Supplemental Order type that “only interacts with small orders to avoid interacting with the price-clearing orders,” the trader contended.
“What the hell is that about? If I go in there with an order to take out the offer, why aren’t I getting everything that is actually offered there? That doesn’t do anybody any good.”
That order type, by Nasdaq’s wording, “provides a final chance for routable orders to execute on Nasdaq, before being routed away” and for suppliers of liquidity “to interact with attractive order flow.” The orders “execute only against orders smaller than the size of the supplemental order interest.”
Much of the problem of proliferation centers around the fact that, even if the process of getting new order types is “onerous,” as Isaacson put it, the number of order types keeps rising inexorably. Figuring out how each works defies the ability of the human brain to absorb, evaluate and adapt.
That’s why the STA’s Setzenfand says, “We would like to see a better notification process for order type filings and inclusion of examples of how order types impact time and price priority.”