[Federal Register Volume 84, Number 249 (Monday, December 30, 2019)]
[Notices]
[Pages 71997-72007]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28024]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-87814; File No. SR-IEX-2019-15]
Self-Regulatory Organizations: Investors Exchange LLC; Notice of
Filing of Proposed Rule Change To Add a New Discretionary Limit Order
Type
December 20, 2019.
Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of
1934 (the ``Act''),\2\ and Rule 19b-4 thereunder,\3\ notice is hereby
given that on December 16, 2019, the Investors Exchange LLC (``IEX'' or
the ``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I and II below, which Items have been prepared by the Exchange.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 15 U.S.C. 78a.
\3\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
(a) Pursuant to the provisions of Section 19(b)(1) under the
Act,\4\ and Rule 19b-4 thereunder,\5\ IEX is filing with the Commission
a proposed rule change to add a new Discretionary Limit order type (a
``D-Limit'' order).
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\4\ 15 U.S.C. 78s(b)(1).
\5\ 17 CFR 240.19b-4.
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The text of the proposed rule change is available at the Exchange's
website at www.iextrading.com, at the principal office of the Exchange,
and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in Sections A, B, and C below, of the
most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to introduce a new order type, a
Discretionary Limit or ``D-Limit'' order, that is designed to protect
liquidity providers from potential adverse selection by latency
arbitrage trading strategies.\6\
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\6\ As proposed, a D-Limit order is also eligible to take
resting liquidity on entry. If not executed on entry, the order will
post to the Order Book and be available to provide liquidity.
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Background
IEX believes that in the current market environment, market
participants that have access to the fastest and most complete view of
market data from all the major exchanges are able to predict imminent
changes to national best bid and offer quotations (``NBBO''),\7\
representing the best displayed bid and offer prices that are available
in the market at any point in time. By sending orders to ``take
liquidity'' against orders that are resting on exchanges or other
trading venues in very small windows of time, generally no more than a
few milliseconds before an anticipated change in the NBBO, trading
firms seeking to exploit these speed and information asymmetry
advantages can profit, to the corresponding disadvantage of
institutional investors and other participants, whose resting orders
are ``picked off'' by these faster firms at ``stale'' prices.
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\7\ The term ``NBBO'' means the national best bid or offer, as
set forth in Rule 600(b) of Regulation NMS under the Act, determined
as set forth in IEX Rule 11.410(b). See IEX Rule 1.160(u).
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IEX further believes that this trading activity creates a
substantial disincentive to market participants to provide exchange
quotes and other orders that rest on exchanges' order books. To
compensate for the resulting adverse selection, among other reasons,
many exchanges employ maker-taker style fee schedules which pay rebates
to liquidity providers that trade on their markets (``Maker-Taker'').
This phenomenon, commonly referred to as ``latency arbitrage,'' has
led to proposals by equity and futures markets specifically designed to
provide protection for resting orders in order to incentivize market
makers and other liquidity providers to maintain tighter spreads with
larger size. Most recently, Cboe EDGA Exchange, Inc. (``EDGA'')
proposed a four-millisecond asymmetrical delay mechanism or ``speed
bump'' that would apply only to incoming executable orders.\8\ As set
forth in its rule change proposal seeking Commission approval of this
asymmetrical speedbump, EDGA states that the purpose of the
asymmetrical speed bump is to provide ``an opportunity for liquidity
providers to process cross-asset signals, and update their published
quotations accordingly, before trading at stale prices with orders
submitted by opportunistic trading firms that benefit from a latency
advantage.'' \9\ The EDGA proposal describes the challenges for
liquidity providers as follows:
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\8\ See Securities Exchange Act Release No. 86168 (June 20,
2019), 84 FR 30282 (June 26, 2019) (SR-CboeEDGA-2019-012).
\9\ See supra note 8, at 30283.
Today, liquidity providers are frequently unable to adjust their
displayed quotes based on changes in market information . . . before
the fastest trading firms can trade against their quotes. Market
makers and other liquidity providers use sophisticated pricing
[[Page 71998]]
algorithms to determine how to price securities in the often
hundreds or thousands of equity securities that they quote. . . .
The potential for trading at stale prices increases risk for firms
that wish to provide liquidity to the market, and harms market
quality by causing liquidity providers to enter quotes that are
wider or for a smaller size than they may otherwise be willing to
trade.\10\
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\10\ See supra note 8, at 30283.
As discussed more fully below, IEX's proposal to establish a D-
Limit order type is designed to protect liquidity providers,
institutional investors as well as market makers, from potential
adverse selection by latency arbitrage trading strategies in a fair and
nondiscriminatory manner, without, as some commenters have mentioned,
introducing concerns around unnecessary complexity, disparate
treatment, and fair access by institutional investors to displayed
quotations that have been voiced with regard to the EDGA asymmetrical
speed bump proposal.\11\
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\11\ See comments on Release No. 34-86168; File No. SR-CboeEDGA-
2019-012 available at: https://www.sec.gov/comments/sr-cboeedga-2019-012/srcboeedga2019012.htm.
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Since before and after it became an exchange, IEX has sought to
design its market in a way that creates a transparent and level playing
field where both investors and market professionals can participate and
have confidence in the fairness of the system. In general, these
aspects of our market involve ways to counter or reduce speed
advantages that can harm investors by exposing them to execution at
stale prices when their orders are traded against by traders with more
complete and timely information about market prices.
These aspects include the use of a so-called ``speed bump,'' a
symmetrical delay mechanism consisting of a length of coiled optical
fiber, which, together with the physical distance from the location
where members connect to the IEX systems where orders are matched,
delays all incoming orders by 350 microseconds. The speed bump is
designed to protect non-displayed orders, typically placed on behalf of
institutional investors, that are ``pegged'' to a given price, often
the midpoint of the NBBO, i.e., the Midpoint Price.\12\ The speed bump
allows IEX's matching engine to update the prices of resting pegged
orders in line with price changes on other markets to lessen the
possibility of adverse selection when a new Midpoint Price is
established. By repricing the order based on the current market,
resting orders are less likely to be executed at stale prices when
incoming orders by other exchange participants with the advantage of a
more current view of market prices seek to execute against resting
pegged orders on IEX.
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\12\ See IEX Rule 1.160(t).
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The speed bump works together with certain non-displayed order
types that are designed to provide further protection to non-displayed
orders and encourage brokers to place those orders on IEX. These
include Discretionary Peg \13\ (``DPeg''), which, in its current
iteration, is an order pegged to trade at one minimum price variation,
or ``tick,'' below the national best bid (``NBB''),\14\ in the case of
buy orders, or one tick above the national best offer (``NBO''),\15\ in
the case of sell orders, unless the submitter of the order has
specified a limit price that is less aggressive than this default
resting price. For most stocks, the minimum tick under Commission rules
is one cent. In most circumstances, DPeg orders can also trade at a
more aggressive price (one more favorable to the counterparty), but
only to the midpoint, when there are incoming orders that are willing
to trade at that price.
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\13\ See IEX Rule 11.190(b)(10). IEX has two other order types
that are based on the DPeg order type: The Retail Liquidity Provider
order and the Corporate Discretionary Peg order. See Rule
11.190(b)(14) and (16).
\14\ The term ``NBB'' shall mean the national best bid, as set
forth in Rule 600(b) of Regulation NMS under the Act, determined as
set forth in IEX Rule 11.410(b). See Rule 1.160(u).
\15\ The term ``NBO'' shall mean the national best offer, as set
forth in Rule 600(b) of Regulation NMS under the Act, determined as
set forth in IEX Rule 11.410(b). See Rule 1.160(u).
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Similarly, the primary peg \16\ (``PPeg'') order type is pegged to
one tick below the NBB, for a buy order, and one tick above the NBO,
for a sell order, but is also available to trade at a price up to the
NBB or down to the NBO, unless further restricted by the order's limit
price. When DPeg and PPeg orders are eligible to trade at prices more
aggressive than their default prices, they are said to be ``exercising
discretion'' to trade at these more aggressive prices.
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\16\ See IEX Rule 11.190(b)(8).
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In addition, IEX uses a proprietary mathematical calculation, the
crumbling quote indicator (``CQI''), to determine when its pegged order
types are eligible to exercise discretion. The CQI is a transparent
formula, codified in IEX's rulebook, designed to predict whether a
particular quote is unstable or ``crumbling,'' meaning that the NBB is
likely about to decline or the NBO is likely about to increase. As set
forth in IEX Rule 11.190(g), the Exchange utilizes real time relative
quoting activity of certain Protected Quotations \17\ and a proprietary
mathematical calculation (the ``quote instability calculation'') to
assess the probability of an imminent change to the current Protected
NBB to a lower price or Protected NBO to a higher price for a
particular security (``quote instability factor''). When the quoting
activity meets predefined criteria and the quote instability factor
calculated is greater than the Exchange's defined quote instability
threshold, the System \18\ treats the quote as unstable and the CQI is
on at that price level for up to two milliseconds (hereafter referred
to as the ``quote instability determination price level'' or the ``CQI
Price''). During all other times, the quote is considered stable, and
the CQI is off. The System independently assesses the stability of the
Protected NBB and Protected NBO for each security.\19\
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\17\ Pursuant to IEX Rule 11.190(g), references to ``Protected
Quotations'' include quotations from the New York Stock Exchange LLC
(``NYSE''); The Nasdaq Stock Market LLC (``Nasdaq''); NYSE Arca,
Inc. (``NYSE Arca''); Nasdaq BX, Inc. (``Nasdaq BX''); Cboe BZX
Exchange, Inc. (``Cboe BZX''); Cboe BYX Exchange, Inc. (``Cboe
BYX''); Cboe EDGX Exchange, Inc. (``EDGX''); and EDGA.
\18\ See IEX Rule 1.160(nn).
\19\ IEX has revised the CQI formula twice since its exchange
launch in order to enhance the accuracy of the CQI in predicting
quote instability and increasing the protection provided to pegged
orders.
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When IEX determines, pursuant to the CQI methodology, that the
current market for a security is unstable--meaning there is a
heightened probability of an imminent quote change at the NBB or NBO--
IEX's System will prevent DPeg and PPeg orders on that side of the
market from exercising discretion and trading at a price that is more
aggressive than their default resting prices. In this way, IEX seeks to
protect these orders from being executed at unfavorable prices during
these very short periods of time when they face a high risk that the
market price will immediately move against them, and IEX's System
allows them to trade at more aggressive prices, with a higher
probability of execution, in all other circumstances.
DPeg and PPeg orders have been widely adopted by a diverse group of
IEX Members. During September 2019, such orders constituted 38% of
overall IEX traded volume (DPeg volume was 35% and PPeg volume was 3%)
and 55% of liquidity adding volume (DPeg volume was 49% and PPeg volume
was 6%). 70 of 145 IEX Members traded using DPeg or PPeg orders (these
Members represent 90% of the total volume traded on IEX), with 84% of
this volume originating from full-service firms, 9% from proprietary
trading
[[Page 71999]]
firms, and 7% from agency firms.\20\ IEX believes that this usage
evidences that a large range of market participants with diverse
business models have a high degree of confidence in the utility of the
CQI formula.
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\20\ See infra note 58 and accompanying text for a discussion of
IEX's classification of its Members' logical order entry ports.
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All of these aspects of IEX's design--the speed bump, the pegged
order types, and the CQI--are designed to work together to provide
better execution opportunities for these orders, which are favored by
institutional investors, by protecting them from being executed at
inferior prices in narrow time windows when the NBBO is in transition.
As described further below, these features have provided substantial
benefits in terms of execution outcomes to investors and other
participants using these IEX order types.
In addition to these other features of IEX's market, since January
1, 2018, IEX has imposed an additional fee on Members that send more
than a certain threshold of their orders to take liquidity during
periods when the CQI is on (the ``CQ Remove Fee''). The CQ Remove Fee
is intended to incentivize participants to send orders to provide
liquidity to IEX by reducing the volume of orders involving trading
strategies that seek to exploit information advantages while the NBBO
is in transition. The CQ Remove Fee has resulted in an incremental
reduction in the use of such strategies on IEX. IEX believes the
limited impact from the fee is a result of the fact that the potential
profits from the use of such strategies substantially exceed the
profits lost from the CQ Remove Fee.\21\
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\21\ The Exchange is effectively limited in setting the CQ
Remove Fee by Rule 610(c) of Regulation NMS. 17 CFR 242.610(c).
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The innovations IEX has introduced have succeeded in providing new
execution opportunities for investors, particularly through the use of
the pegged order types described above, and they have provided IEX
participants with opportunities for improved executions compared to
other venues.\22\ At the same time, IEX believes that the willingness
of market participants to provide liquidity through other order types,
including displayed orders, is substantially negatively affected by the
trading strategies described above. Without an order type that
leverages the protective features of the CQI, 24% of displayed volume
on IEX is executed when the CQI is on, compared to only 3% of
nondisplayed volume during September 2019. As discussed in detail
below, IEX trading data reveals that liquidity-providing orders that
are executed while the CQI is on are subject to significant differences
in short term markouts,\23\ compared to liquidity-providing orders
executed when the CQI is off, and the significant volume of orders that
are sent during these very small time intervals (on IEX as well as
other exchanges) accentuates this impact.
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\22\ See, e.g., Wah, Elaine, et al. ``A Comparison of Execution
Quality across U.S. Stock Exchanges,'' (April 19, 2017), available
at https://iextrading.com/docs/A%20Comparison%20of%20Execution%20Quality%20across%20U.S.%20Stock%20Exchanges.pdf.
\23\ The term markouts refers to changes in the midpoint of the
NBBO measured from the perspective of either the liquidity providing
resting order or liquidity removing taking order over a specified
period of time following the time of execution.
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Maker-Taker exchanges use rebate payments to induce participants to
post quotes and other resting orders on exchanges notwithstanding these
negative impacts. A variety of significant concerns have been raised
regarding the effect of paying rebates as compensation to a relatively
small number of liquidity providers, which include conflicts of
interest, increased market fragmentation, effectiveness, and adding
unnecessary complexity to overall equity market structure by
incentivizing market participants to attempt to continually readjust
their order routing to navigate a multitude of constantly changing
transaction fee schedules.\24\ The Commission has adopted a transaction
fee pilot, to assess these concerns about existing exchange fee
structures, which is designed to test potential improvements to market
quality from reducing access fees and prohibiting rebates on all
exchanges.\25\ Moreover, the substantial use of ``Taker-Maker''
exchange fee models, which charge fees to liquidity providing orders
and pay rebates to liquidity taking orders, evidences that exchanges
can compete for displayed order flow without paying rebates.
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\24\ See generally, transcript of Commission ``Roundtable on
Market Data Products, Market Access Services, and their Associated
Fees'' (October 25, 2018) available at: https://www.sec.gov/spotlight/equity-market-structure-roundtables/roundtable-market-data-market-access-102518-transcript.pdf.
\25\ See Securities Exchange Act Release 84875 (December 19,
2018); 84 FR 5202 (February 20, 2019).
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In view of these factors, the Exchange believes that it is
appropriate to also leverage the CQI to expand the IEX protective
design to displayed and non-pegged non-displayed limit orders.\26\ The
Exchange further believes that providing such protection would
incentivize the entry of liquidity providing orders on IEX by
protecting such orders from adverse selection by market participants
leveraging sophisticated latency arbitrage strategies to exploit
informational advantages when IEX's probabilistic model determines that
the market appears to be moving adversely to them.
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\26\ IEX currently allows limit orders to be either ``displayed,
non-displayed, or partially displayed.'' See IEX Rule 11.190(a)(1).
Displayed orders must be limit orders, see IEX Rule 11.190(b)(1),
but non-displayed orders can be either a market, limit, or pegged
order. See IEX Rule 11.190(b)(3). Furthermore, pegged orders can be
submitted with or without a limit price, with the exception of
Market Maker Peg orders, which must be limit orders. See IEX Rule
11.190(b)(8), (9), (10), (13), and (16).
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Accordingly, IEX is proposing the D-Limit order type as an
alternative means of encouraging market makers and other participants,
including institutional investors, to provide liquidity, by adjusting
the price of these orders in the narrow time windows when the CQI is
on, to better protect them from being ``picked off'' during those
intervals. IEX believes that D-Limit represents a logical extension of
its efforts to date to create a trading platform that encourages
participation by investors and market professionals and maximizes
opportunities for investors to trade at a fair price. D-Limit orders
would be available to all IEX Members in a fair and nondiscriminatory
manner.
As discussed further below, IEX believes that exchanges must be
allowed to innovate in narrowly targeted ways to protect resting orders
from being unfairly exploited by information asymmetries. IEX also
believes such measures are important to enhance the value and integrity
of protected quotes generally, and that D-Limit will benefit market
quality by leading to deeper liquidity, displayed and non-displayed,
and increased opportunities for participants interacting with this
liquidity to receive favorable executions.
Proposal
The Exchange proposes to amend IEX Rule 11.190(b)(7), which is
currently reserved, to add a D-Limit order which may be a displayed or
non-displayed limit order that upon entry and when posting to the Order
Book,\27\ is priced to be equal to and ranked at the order's limit
price,\28\ but will be adjusted to a less-aggressive price during
periods of quote instability, as defined in IEX Rule 11.190(g), as
described more fully
[[Page 72000]]
below. Otherwise, a D-Limit order will operate in the same manner as a
displayed or non-displayed limit order, as applicable.
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\27\ See IEX Rule 1.160(p).
\28\ A non-displayed D-Limit order with a limit price more
aggressive than the Midpoint Price will be subject to the Midpoint
Price Constraint and be booked and ranked on the Order Book at a
price equal to the Midpoint Price pursuant to IEX Rule 11.190(h)(2).
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As proposed, if upon entry of a D-Limit buy (sell) order the CQI is
on and the order has a limit price equal to or higher (lower) than the
quote instability determination price level (i.e., the CQI Price), the
price of the order will be automatically adjusted by the System to one
(1) MPV \29\ lower (higher) than the CQI price. Similarly, when
unexecuted shares of a D-Limit buy (sell) order are posted to the Order
Book, if a quote instability determination is made and such shares are
ranked and displayed (in the case of a displayed order) by the System
at a price equal to or higher (lower) than the CQI Price, the price of
the order will be automatically adjusted by the System to one (1) MPV
lower (higher) than the CQI Price. A D-Limit order that is subject to
an automatic adjustment will not revert to the price at which it was
previously ranked and displayed (in the case of a displayed order).
Once the price of a D-Limit order that has been posted to the Order
Book is automatically adjusted by the System, the order will continue
to be ranked and displayed (in the case of a displayed order) at the
adjusted price, unless subject to another automatic adjustment, or if
the order is subject to the price sliding provisions of IEX Rule
11.190(h). When the price of a D-Limit order is adjusted the order will
receive a new time priority. If multiple D-Limit orders are adjusted at
the same time, their relative time priority will be maintained.
Further, when the price of a D-Limit order is adjusted, the Member that
entered the order will receive an order restatement message from the
Exchange notifying the Member of the price adjustment.\30\
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\29\ See IEX Rule 11.210.
\30\ A restatement notice is an automated message from the
Exchange System informing the Member that the price of its order has
been adjusted.
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D-Limit orders are subject to the price sliding provisions of IEX
Rule 11.190(h), as noted above. This provision provides for price
sliding in the event of a locked or crossed market, to enforce the
Midpoint Price Constraint,\31\ to comply with the display or execution
requirements for a short sale order not marked short exempt during a
Short Sale Period,\32\ or to comply with the Limit Up-Limit Down Price
Constraint.\33\ As set forth in IEX Rule 11.190(h), an order that has
been subject to price sliding will be repriced back to its more
aggressive limit price when the market condition changes such that the
condition necessitating the price sliding is no longer applicable.\34\
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\31\ See note 28 supra.
\32\ See IEX Rule 11.290(d).
\33\ See IEX Rule 11.190(h)(5).
\34\ See IEX Rule 11.190(h) for a complete description of the
price sliding provisions. See also note 28 supra regarding
applicability of the Midpoint Price Constraint.
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Pursuant to proposed IEX Rule 11.190(b)(7), a D-Limit order:
(A) Must be submitted with a limit price.
(B) May have a TIF of DAY, GTX, SYS or GTT.
(C) Is not eligible for routing pursuant to IEX Rule 11.230(b)
and (c)(2).
(D) May not be an ISO.\35\
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\35\ See IEX Rule 11.190(b)(12).
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(E) Is eligible to trade only during the Regular Market
Session.\36\ A D-Limit order marked with a TIF of DAY that is
submitted to the System before the opening of the Regular Market
Session will be queued by the System until the start of the Regular
Market Session; a D-Limit order marked with a TIF other than DAY
will be rejected when submitted to the System during the Pre-Market
Session.\37\ A D-Limit order submitted into the System after the
closing of the Regular Market Session will be rejected.
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\36\ See IEX Rule 1.160(gg).
\37\ See IEX Rule 1.160(z).
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(F) May not be a minimum quantity order.\38\
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\38\ See IEX Rule 11.190(b)(11).
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(G) May be an odd lot, round lot, or mixed lot. However, a D-
Limit order marked for display will not be displayed unless it is at
least one round lot. If a D-Limit order marked for display is
submitted with, or decremented either by execution or the User order
amendment to an order quantity of less than one round lot, it will
be treated as an odd lot order which is, by definition, non-
displayed and will receive a new time stamp, pursuant to IEX Rule
11.220(a)(3).
(H) May not be a Reserve Order.\39\
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\39\ See IEX Rule 11.190(b)(2).
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(I) Displayed Discretionary Limit orders are not eligible to be
invited by the System to Recheck as described in IEX Rule
11.230(a)(4)(D).
(J) Discretionary Limit orders are subject to the Price Sliding
provisions of IEX Rule 11.190(h).
The proposed rule change would thus extend the protective features
of the CQI to displayed and non-displayed D-Limit orders to protect
such orders from potential adverse selection by preventing them from
trading at a price that IEX's CQI formula predicts is unstable and thus
imminently stale.
The following examples illustrate the operation of the price
adjustment functionality of D-Limit orders: \40\
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\40\ The following examples all describe D-Limit buy orders.
Each of the examples also applies to a D-Limit sell order, except
that any price adjustments to a D-Limit sell order would adjust the
order price to one MPV above the CQI Price in effect.
1. The PBBO \41\ in XYZ is 10.05-10.10 and a displayed D-Limit
order to buy with a limit price of 10.05 is resting on the IEX Order
Book at its limit price. A quote instability determination is made
at the PBB \42\ of 10.05. Because the limit (and displayed) price of
the D-Limit order is equal to the CQI Price, the price of the order
is adjusted to 10.04.
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\41\ The term ``PBBO'' refers to the national best bid or offer
that is a protected quotation, determined as set forth in IEX Rule
11.410(b). See IEX Rule 1.160(cc).
\42\ The term ``PBB'' refers to the national best bid that is a
protected quotation, determined as set forth in IEX Rule 11.410(b).
See IEX Rule 1.160(cc).
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2. The PBBO in XYZ is 10.05-10.10 and a displayed D-Limit order
to buy with a limit price of 10.04 is resting on the IEX Order Book
at its limit price. A quote instability determination is made at the
PBB of 10.05. Because the limit and displayed price of the D-Limit
order is less than the CQI Price, the price of the order is not
adjusted.
3. Following the order adjustment in Example 1, the PBB reverts
to 10.05. The order remains displayed at its adjusted limit price of
10.04 because a D-Limit order that has been adjusted continues to be
ranked and displayed at its adjusted price, regardless of a change
in the PBB, unless subject to another automatic adjustment.
4. Following the order adjustment in Example 1, a new quote
instability determination is made at the PBB of 10.04. Because the
limit and displayed price of the D-Limit order is equal to the CQI
Price, the price of the order is adjusted again to 10.03.
5. Following the order adjustment in Example 1, the PBB reverts
to 10.05 and a new quote instability determination is made at the
PBB of 10.05. Because the limit and displayed price of the D-Limit
order is lower than the CQI Price, the price of the order is not
adjusted.
6. The PBBO in XYZ is 10.05-10.10 and a non-displayed D-Limit
order to buy with a limit price of 10.06 is resting on the IEX Order
Book at its limit price. A quote instability determination is made
at the PBB of 10.05. Because the limit price of the D-Limit order is
higher than the CQI Price, the price of the order is adjusted to
10.04.
7. The PBBO in XYZ is 10.05-10.10 and a non-displayed D-Limit
order to buy with a limit price of 10.05 is resting on the IEX Order
Book at its limit price. A quote instability determination is made
at the PBB of 10.05. Because the limit price of the D-Limit order is
equal to the CQI Price, the price of the order is adjusted to 10.04.
Subsequently, the PBB moves to 10.03 and a new quote instability
determination is made at the PBB of 10.03. The price of the order is
adjusted to a price of 10.02.
8. The PBBO in XYZ is 10.05-10.10 and the quote instability
determination is in effect for the PBB at 10.05. A D-Limit order to
buy XYZ with a limit price of 10.05 enters the IEX Order Book.
Because the limit price of the order is equal to the CQI Price in
effect, the price of the order is adjusted to and booked at
10.04.\43\
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\43\ The order is not executable on entry at 10.04 because of
the Midpoint Price Constraint. Pursuant to IEX Rule 11.190(h)(2), a
non-displayed limit order posting to the Order Book which has a
limit price more aggressive than the Midpoint Price will be booked
and ranked on the Order Book non-displayed at a price equal to the
Midpoint Price.
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9. The PBBO in XYZ is 10.05-10.10 and the quote instability
determination is in
[[Page 72001]]
effect for the PBB at 10.05. A D-Limit order to buy XYZ with a limit
price of 10.04 enters the IEX Order Book. Because the limit price of
the order is lower than the CQI Price in effect, the price of the
order is not adjusted.\44\
---------------------------------------------------------------------------
\44\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------
10. The PBBO in XYZ is 10.05-10.10 and the quote instability
determination is in effect for the PBB at 10.05. A D-Limit order to
buy XYZ with a limit price of 10.06 enters the IEX Order Book.
Because the limit price of the order is higher than the CQI Price in
effect, the price of the order is adjusted to and booked at
10.04.\45\
---------------------------------------------------------------------------
\45\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------
11. The PBBO in XYZ is 10.05-10.10 and the quote instability
determination is in effect for the PBB at 10.05. The PBB crumbles to
10.04 but the quote instability determination is still in effect at
10.05. A D-Limit order to buy XYZ with a limit price of 10.05 enters
the IEX Order Book. Because the limit price of the order is equal to
the CQI Price in effect, the price of the order is adjusted to and
booked at 10.04.\46\
---------------------------------------------------------------------------
\46\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------
12. The PBBO in XYZ is 10.04-10.10 and the quote instability
determination is in effect at 10.05 (the prior PBB). A D-Limit order
to buy XYZ with a limit price of 10.05 enters the IEX Order Book.
Because the limit price of the order is equal to the CQI Price in
effect, the price of the order is adjusted to and booked at
10.04.\47\
---------------------------------------------------------------------------
\47\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------
13. The PBBO in XYZ is 10.04-10.10 and the quote instability
determination is in effect at 10.05 (the prior PBB). A D-Limit order
to buy XYZ with a limit price of 10.06 enters the IEX Order Book.
Because the limit price of the order is higher than the CQI Price in
effect, the price of the order is adjusted to and booked at
10.04.\48\
---------------------------------------------------------------------------
\48\ The order is not executable on entry. See supra note 43.
---------------------------------------------------------------------------
14. The PBBO in XYZ is 10.04-10.10 and the quote instability
determination is in effect at 10.05 (the prior PBB). A D-Limit order
to buy XYZ with a limit price of 10.04 enters the IEX Order Book.
Because the limit price of the order is lower than the CQI Price in
effect, the price of the order is booked at 10.04.\49\
---------------------------------------------------------------------------
\49\ The order is not executable on entry. See supra note 43.
D-Limit orders would be available to all Members on a fair and
impartial basis and no particular technology or access to high speed
connectivity or market data is necessary to obtain the protective
benefits of a D-Limit order. The Exchange will adjust the price of a D-
Limit order based on the transparent, rule-based CQI formula. In
contrast, the use of ``asymmetric'' speed bumps (those imposed only on
the taker of liquidity) in order to provide a benefit to resting
orders, requires access to sophisticated technology, connectivity and
market data in order to cancel or adjust an order in the brief time
period that an incoming order is delayed.
IEX is not proposing any changes to IEX Rule 11.240(c) which
specifies that the System operates as an ``automated market center''
and displays ``automated quotations'' within the meaning of Regulation
NMS, except in the event that a systems malfunction renders the System
incapable of displaying automated quotations. Automated quotations of
an automated trading center are protected quotations pursuant to Rule
600(b)(62) of Regulation NMS \50\ and entitled to trade-through
protection pursuant to Rule 611 of Regulation NMS \51\ (the ``Order
Protection Rule''). Consequently, displayed D-Limit orders will qualify
as automated quotations within the meaning of Regulation NMS (except in
the event that a systems malfunction renders the System incapable of
displaying automated quotations).\52\
---------------------------------------------------------------------------
\50\ 17 CFR 242.600(b)(62).
\51\ 17 CFR 242.611.
\52\ 17 CFR 242.602(a)(3)(i).
---------------------------------------------------------------------------
2. Statutory Basis
IEX believes that the proposed rule change is consistent with the
provisions of Section 6(b) \53\ of the Act in general, and furthers the
objectives of Section 6(b)(5) of the Act \54\ in particular, in that it
is designed to prevent fraudulent and manipulative acts and practices,
to promote just and equitable principles of trade, to remove
impediments to and perfect the mechanism of a free and open market and
a national market system, and, in general, to protect investors and the
public interest. Specifically, the Exchange believes the proposed rule
change is consistent with the protection of investors and the public
interest because it is designed to protect resting D-Limit orders from
adverse selection associated with latency arbitrage by limiting
execution to one MPV lower than the CQI Price (for buy orders) or one
MPV higher than the CQI Price (for sell orders) when the Exchange's
probabilistic model identifies that the NBB or NBO appears to be moving
adversely to them, thereby reducing the potential to execute at an
imminently stale price.
---------------------------------------------------------------------------
\53\ 15 U.S.C. 78f.
\54\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
In addition, the Exchange believes that the proposed rule change is
consistent with the protection of investors and the public interest
because it is designed to incentivize the entry of additional resting
orders, including displayed orders on the Exchange, thereby enhancing
price discovery and the overall liquidity profile on the Exchange to
the benefit of all market participants. Based on market data analysis
during September 2019, the Exchange identified that there are
significant differences in short term markouts (and pro forma profit
and loss) \55\ for resting and taking orders between executions when
the CQI is on and off, regardless of whether the NBB (NBO) moves lower
(higher) within two milliseconds of the Exchange's determination of
quote instability. Specifically, when the CQI is on, liquidity removing
orders that execute on IEX (trading with a liquidity providing order
resting on the Order Book, including but not limited to Discretionary
Peg and primary peg orders) experience positive price markouts one
second after the trade on a share basis 76% of the time, compared to
23.5% of the time when the CQI is off. Correspondingly, resting
liquidity providing orders that trade when the CQI is on experience
negative price markouts one second after the trade 76% of the time,
compared to 23.5% of the time when CQI is off. Similarly, 55.9% of all
orders received when the CQI is on (whether or not executed on IEX)
arrive immediately prior to a favorable price move (based on one second
markouts), compared to 19.5% of orders received when the CQI is off.
---------------------------------------------------------------------------
\55\ For purposes of this analysis, a pro forma profit or loss
is calculated as the difference between the midpoint of the NBBO at
the time of the execution compared to one second after.
---------------------------------------------------------------------------
Moreover, the breakdown of orders entered and shares removed when
the CQI is on or off evidences that certain trading strategies appear
to involve entering liquidity taking orders targeting resting orders at
prices that are likely to imminently move adversely from the
perspective of the resting order. Across all approximately 8,000
symbols available for trading on IEX, the CQI is on only 1.64 seconds
per symbol per day on average (0.007% of the time during regular market
hours),\56\ but 33.7% of marketable orders \57\ are received during
those time periods, which indicates that certain types of trading
strategies are seeking to
[[Page 72002]]
aggressively target liquidity providers during periods of quote
instability.
---------------------------------------------------------------------------
\56\ On a volume weighted basis, the CQI is on for 5.9 seconds
per day per symbol, 0.025% of the time during regular market hours.
IEX plans to file a proposed rule change with the Commission shortly
to incrementally optimize and enhance the effectiveness of the quote
instability calculation in determining whether the CQI is on. Based
on a modeling analysis, IEX estimates that the updated calculation
will result in the CQI being on 0.009% of the time during regular
market hours, on average, and incrementally increase the expected
number of CQI determinations by approximately 20%.
\57\ An order is considered marketable for this analysis if it
was a market order or its limit price is at or more aggressive than
the contra-side quotation.
---------------------------------------------------------------------------
Further, based upon IEX's classification of its Members' logical
order entry ports (also known as ``sessions'') as originating from
proprietary trading firms, full service broker-dealers, or agency
broker-dealers,\58\ proprietary trading firms are more likely to seek
to trade against IEX resting orders while the CQI is on, while sessions
classified as full-service and agency are more likely to seek to trade
against IEX resting orders during the remainder of the day. Within the
two millisecond periods following CQI determinations, proprietary
trading firms submit 6.8 times as many marketable-to-mid shares (i.e.,
shares priced at least as aggressively as the midpoint and eligible to
trade) compared to full-service and agency firms; while outside of
those two millisecond periods, the situation is reversed, with full-
service and agency firms submitting 3.4 times as many marketable-to-mid
shares compared to proprietary trading firms (based on daily averages
from September 2019).
---------------------------------------------------------------------------
\58\ On a best efforts basis, IEX classifies proprietary trading
firms as those that are trading for their own account rather than
acting in an agency capacity for an independent beneficial owner.
Agency broker-dealers are firms that trade on behalf of customers
that are independent beneficial owner but do not commit capital to
facilitate their customers' orders. Full-service broker-dealers are
also trading on behalf of an independent beneficial owner but they
also have the ability to commit capital to facilitate a customer
order.
---------------------------------------------------------------------------
When looking at the impact of trading when the CQI is on and off
for non-pegged limit orders, the data strongly supports that such
orders are systematically subjected to adverse impacts of latency
arbitrage strategies. During September 2019, non-pegged limit orders
accounted for 17% of volume traded on IEX (13% of traded volume was
from displayed limit orders). In the aggregate, these orders
experienced significant differences in short term markouts (and pro
forma profit and loss) between executions when the CQI is on and off,
regardless of whether the NBB (NBO) moves lower (higher) within two
milliseconds of the Exchange's determination of quote instability.
Resting limit orders that trade when the CQI is on experience negative
price markouts one second after the trade 76% of the time, compared to
34% of the time when CQI is off. In addition, for marketable incoming
orders to take liquidity that arrive when IEX has a displayed quote,
21% arrive during the 0.007% of the trading day when the CQI is on.
Moreover, for displayed limit orders that added liquidity during
September 2019, the disparity in markouts between such orders that
traded when the CQI was on versus off was material and evident of
latency arbitrage.\59\ For such orders that traded when the CQI was on,
the average markouts were negative $.0036 per share ten milliseconds
after trade time. In contrast, when the CQI was off, the average
markouts were positive $.0045 at 10 milliseconds, a performance
difference of $.0081 per share at 10 milliseconds post trade. From one
second through five minutes the performance difference between CQI on
vs CQI off trades was never smaller than $.0048 per share.
---------------------------------------------------------------------------
\59\ See Stockland, Eric. ``Modern Day Latency Arbitrage:
Predicting Price Changes,'' (April 10, 2017), available at https://medium.com/boxes-and-lines/modern-day-latency-arbitrage-predicting-price-changes-738edc25a28d.
---------------------------------------------------------------------------
The Exchange believes that this data is particularly significant
and evidences that Members entering liquidity taking orders when the
CQI is on appear to be able to engage in a form of latency arbitrage by
leveraging fast proprietary market data feeds and connectivity along
with predictive strategies to chase short-term price momentum and
successfully target resting orders at unstable prices. IEX believes
that these types of trading strategies, with concentrated and
aggressive tactics during moments of quote instability, are detrimental
to the experience of other IEX participants. As further discussed
below, IEX believes that such trading strategies create disparate
burdens on resting orders, particularly limit orders that do not
currently benefit from the CQI or the speedbump.
The Exchange believes that IEX data thus demonstrates that
displayed and non-displayed limit orders are subject to systematic
adverse impacts from latency arbitrage strategies. The Exchange
believes that these adverse impacts constitute an implicit tax on
liquidity providers that operates to disincentivize market participants
from entering limit orders that contribute to meaningful price
discovery. Other exchanges use rebates and volume tiers to essentially
compensate market makers and other liquidity providers for posting
aggressive limit orders.\60\ As discussed above, IEX believes that
these pricing schemes can contribute to a number of conflicts of
interest and market distortions including, among others, conflicts of
interests, excess intermediation and potential adverse selection,
market fragmentation, complexity, the proliferation of new order types
to enable avoidance of fees, and elevated fees to subsidize
rebates.\61\ In contrast, IEX seeks to incentivize liquidity providing
orders through superior execution quality, but this incentive can be
undercut by trading strategies that target resting orders during
periods of quote instability. Thus, IEX believes that additional
approaches to incentivize displayed liquidity are warranted, and that
the D-Limit order type is one reasonable approach to compete with other
venues for liquidity providing order flow without relying on rebates
and tiered pricing. As discussed above, the widespread adoption of DPeg
and PPeg order types that utilize the CQI formula evidences that a
diverse group of Members have confidence in the utility of the CQI and
its protective features. IEX believes that, as a result, a similarly
diverse group of Members are likely to use D-Limit orders.
---------------------------------------------------------------------------
\60\ See, e.g., NYSE Price List 2019, available at https://www.nyse.com/publicdocs/nyse/markets/nyse/NYSE_Price_List.pdf; see
also Nasdaq General Equity and Options Rule, Equity 7 Section
118(a)(1) available at http://nasdaq.cchwallstreet.com/NASDAQTools/PlatformViewer.asp?selectednode=chp%5F1%5F1%5F2%5F2&manual=%2Fnasdaq%2Fmain%2Fnasdaq%2Dllcrules%2F; Cboe BZX U.S. Equities Exchange Fee
Schedule, available at https://markets.cboe.com/us/equities/membership/fee_schedule/bzx/.
\61\ See Wah, Elaine, ``Gone in Sixty Seconds'' (September 21,
2018) available at: https://medium.com/boxes-and-lines/gone-in-sixty-seconds-22094adeb0de.
---------------------------------------------------------------------------
The Exchange further believes that the proposed rule change is
consistent with the Act because it would be available to all Members on
a fair, equal and nondiscriminatory basis. All Members, regardless of
their technological sophistication, can enter D-Limit orders and
benefit from their protection against latency arbitrage. More
specifically, a Member using a D-Limit order would not need to be able
to have the technological capability (e.g., through the use of high
speed connectivity and market data purchased from other exchanges) to
identify that the quote is unstable and send an order message to cancel
or reprice its resting order faster than another Member with such
technological capability can trade against the order. The Exchange will
adjust the price of a D-Limit order based on the transparent, rule-
based CQI formula.
IEX believes the fact that the D-Limit order is specifically
designed to disincentivize trading strategies seeking to take liquidity
while the CQI is on does not amount to ``unfair discrimination between
customers, issuers, brokers, or dealers,'' within the meaning of the
Act. The existing equity market structure is replete with
[[Page 72003]]
examples of exchange rules that seek to incentivize, disincentivize, or
deter various types of trading activity. Maker-Taker price structures,
which are used by all the largest exchanges, by their nature provide
more favorable exchange economics to liquidity-providing compared to
liquidity-taking activity. Nasdaq charges ``excess order fees'' on
certain members that have a relatively high ratio of orders entered
away from the NBBO to orders that are executed, subject to carve-outs
for certain low-volume members and certain registered market
makers.\62\ Nasdaq justified the fee based on its design to improve the
quality of displayed liquidity to the benefit of all market
participants.\63\
---------------------------------------------------------------------------
\62\ See Nasdaq General Equity and Options Rule, Equity 7
Section 118(m).
\63\ See Securities Exchange Act Release No. 66951 (May 9,
2012), 77 FR 28647 (May 15, 2012) (SR-NASDAQ-2012-055).
---------------------------------------------------------------------------
Further, IEX's CQI Remove Fee is expressly designed to benefit and
incentivize the placing of resting, non-displayed orders by limiting
the profitability of the same trading strategies that motivate the
current proposal. Moreover, IEX's existing speed bump is designed to
limit executions of non-displayed, pegged orders before the Exchange
has the ability to update and reprice those orders based on its own
view of market prices. In approving the speed bump, the Commission
found that:
IEX's [speed bump] is thus narrowly designed to allow IEX to
update the prices of non-displayed resting pegged orders so that
they can achieve their intended purpose--pricing that is accurately
benchmarked to the NBBO. . . . The Commission thus finds that IEX's
ability to update the prices of resting pegged orders . . . is not
designed to unfairly discriminate among members to the detriment of
investors or the public interest and is intended to benefit
investors that post pegged orders.'' \64\
---------------------------------------------------------------------------
\64\ Securities Exchange Act Release No. 78101 (June 17, 2016),
81 FR 41142, 41157 (June 23, 2016).
The Exchange believes that it is similarly not unfairly
discriminatory to use a narrowly tailored means to provide protection
to and encourage the placing of displayed limit orders on IEX by
investors and market makers by providing them a measure of protection
from the trading strategies documented above. The Exchange further
believes that the proposed rule change is consistent with the
protection of investors and the public interest because the
circumstances under which a D-Limit order will be adjusted are narrowly
tailored, transparent and predictable. As discussed above, the CQI is
only on for an extremely small percentage of the trading day and is
designed to protect impacted order types during these very narrow
windows of time. Even if IEX enhances the CQI formula (as noted above),
the nature of the CQI will remain intact--it will continue to focus on
protecting impacted orders against latency arbitrage trading strategies
during very narrow windows of time. Even though D-Limit orders may not
be accessible to other market participants during these narrow
timeframes, the Exchange does not believe that this impact is unfairly
discriminatory because during the vast majority of time D-Limit quotes
will be accessible. Moreover, the purpose of limiting such
accessibility is to incentivize liquidity providers to post displayed
orders on IEX by protecting them as discussed above. To the extent that
such incentive is successful, all market participants, including takers
of liquidity, will benefit.
The CQI formula used to determine whether and when to adjust an
order's price is codified in IEX Rule 11.190(g) and is, on average, on
for only 0.007% of the trading day for each security. During the
remaining 99.993% of the trading day, D-Limit orders would be available
to trade at their resting price in the same manner as any other limit
order. In contrast, whether an order will be cancelled or adjusted in
an exchange with an asymmetrical speed bump would not be transparent or
predictable since such changes are determined exclusively by the market
participant that entered the order. Further, the price of a D-Limit
order would only be adjusted when the CQI formula predicts that the
relevant quote is unstable while an asymmetrical speed bump enables a
market participant to cancel or adjust the price of an order on an ad
hoc basis for any reason and frequency.
Notwithstanding that D-Limit orders will be subject to price
adjustment when the CQI is on, IEX believes that this functionality is
consistent with the ``firm quote'' requirements of Regulation NMS Rule
602(b) \65\ in that it will not result in a meaningful amount of quote
``fading'' compared to the quote fading, both explicit and implicit,
that exists and is permitted today. This quote fading falls into three
broad categories.
---------------------------------------------------------------------------
\65\ 17 CFR 242.602(b).
---------------------------------------------------------------------------
First, several other exchanges offer displayed order types that are
pegged to the NBBO and thus are subject to price adjustments, including
to a less aggressive price as the NBBO changes (i.e., explicit quote
fading). EDGA, for example, offers a MidPoint Discretionary order that
is pegged to the same-side NBB or NBO with discretion to execute at
more aggressive prices up to and including the midpoint of the NBBO or
the order's limit price.\66\ A MidPoint Discretionary order can be
displayed or non-displayed. In the case of a displayed MidPoint
Discretionary order, the order's display price is adjusted in response
to changes in the NBB (for buy orders) or NBO (for sell orders) which
can result in a displayed order being adjusted to a less aggressive
price than it was previously displayed at if the NBB or NBO moves to a
less aggressive price. Thus, displayed MidPoint Discretionary orders
are subject to quote fading if the NBB or NBO, as applicable, moves to
a less aggressive price. IEX believes that this price adjustment
functionality is substantially similar to the proposed D-Limit price
adjustment functionality in that both order types will adjust to a less
aggressive price in response to certain objective criteria. The
displayed price of a MidPoint Discretionary order will move to a less
aggressive price if the NBB or NBO moves to a less aggressive price,
while the displayed price of a D-Limit order will move to a less
aggressive price if IEX's CQI formula predicts that the NBB or NBO is
likely to move to a less aggressive price.
---------------------------------------------------------------------------
\66\ See EDGA Equity Rule 11.8(e).
---------------------------------------------------------------------------
EDGA adopted the MidPoint Discretionary order through an
immediately effective rule filing.\67\ Four years later, EDGA's
affiliate, EDGX filed an immediately effective rule filing to adopt a
comparable MidPoint Discretionary order type, the displayed version of
which is also pegged to the same-side NBB or NBO and thus subject to
price adjustments to a less aggressive price when the NBBO moves to
such a price.\68\ Neither the EDGA nor EDGX rule filings raised any
issues or concerns regarding quote fading of displayed MidPoint
Discretionary orders. In addition, Nasdaq offers a discretionary order
type for which the display price can be pegged to a floating price
range \69\ and NYSE Arca and NYSE each offers a primary pegged order
type that has a
[[Page 72004]]
working price pegged to the same-side PBBO that must include a minimum
of one round lot displayed.\70\ Thus, these displayed pegged orders
will also be adjusted to a less aggressive price when the same-side
NBBO or PBBO, as applicable, moves to a less aggressive price.
Similarly, the Commission's approval of a Nasdaq rule filing that
includes adoption of its displayed discretionary order type does not
include any discussion of potential quote fading issues.\71\
---------------------------------------------------------------------------
\67\ See Securities Exchange Act Release No. 67226 (June 20,
2012), 77 FR 38113 (June 26, 2012) (SR-EDGA-2012-022) (Notice of
Filing and Immediate Effectiveness to Amend EDGA Rules to Add the
MidPoint Discretionary order). Two years later, in 2014, EDGA filed
another rule change proposal to restructure its order type rules,
including the MidPoint Discretionary order. See Securities Exchange
Act Release No. 73592 (November 13, 2014), 79 FR 68937 (November 19,
2014) (SR-EDGA-2014-020).
\68\ See Securities Exchange Act Release No. 84327 (October 1,
2018), 83 FR 50416 (October 5, 2018) (SR-CboeEDGX-2018-041).
\69\ See Nasdaq Rule 4703(g) and Section 3.3.2 of Nasdaq's SUMO
FIX Programming Specification for FIX 4.2 available at: https://nasdaqtrader.com/content/technicalsupport/specifications/TradingProducts/fix_orders_sb.pdf.
\70\ See NYSE Arca Rule 7.31-E(h)(2) and NYSE Rule 7.31(h)(2).
\71\ See Securities Exchange Act Release No. 75252 (June 22,
2015), 80 FR 36865 (June 26, 2015) (SR-NASDAQ-2015-024).
---------------------------------------------------------------------------
Data for September 2019 identified that there were approximately
5,500 volume-weighted average NBBO quote changes per symbol each day to
a less aggressive price, compared to 5,427 volume-weighted average CQI
determinations per symbol each day. IEX believes that this data
evidences that D-Limit orders would be subject to a comparable number
of changes to a less aggressive price as order types of other exchanges
that peg to the near side NBBO or PBBO. And as discussed earlier, the
CQI is on for only 1.64 seconds per symbol per day on average (0.007%
of the time during regular market hours). Thus, IEX believes that this
data supports that D-Limit, like the other exchanges' order types
discussed above, is a narrowly tailored approach to provide for price
adjustments to a less aggressive price for displayed orders pursuant to
transparent and objective criteria. IEX believes that order types that
are subject to repricing in response to an exchange determining that
the NBBO has changed provide relevant precedent to repricing based on
an exchange determining--pursuant to a transparent formula--that the
NBBO is likely in the process of changing. In both cases, the repricing
trigger is based on the NBBO. Although D-Limit orders would be repriced
based on a transparent formula predicting an imminent change to the
NBBO, rather than an exchange's determination that the NBBO has
changed, the formula is narrowly tailored, designed to provide
protection to market participants at all levels of sophistication, and
codified in an IEX rule. And in both cases, the automatic change to the
quote's price is explicitly intended to prevent executions at the
originally displayed price. While the D-Limit proposal is novel in that
it would provide an exchange with flexibility to reprice a displayed
order, that flexibility is limited by the narrowly tailored CQI formula
which itself is based on publicly available market data inputs and
designed to protect liquidity providers from adverse selection by
latency arbitrage trading strategies. Although such protection is
designed to benefit liquidity providers, IEX believes that it will also
benefit liquidity takers to the extent that the protection results in
more resting liquidity available to liquidity takers. Consequently, IEX
believes that its D-Limit order type proposal is approvable in
accordance with this precedent.
Second, explicit quote fading exists on options exchanges, which
offer several mechanisms to assist their members in managing risk and
avoiding unintended executions. These mechanisms include risk
management functionality that will automatically cancel resting orders
and quotes based on member configured triggers such as total traded
volume, percent traded volume, notional, net Delta or Vega
exposure.\72\ Notably, the automatic triggers appear to occur inside
the exchange matching engine as opposed to requiring an order or cancel
message from the member. Other exchanges also offer order and quote
purge functionality that is designed to help members manage risk by
providing dedicated (and effectively faster) ports to enter mass
cancellations of multiple resting orders.\73\ While IEX appreciates
that market makers and other market participants posting displayed
orders on options exchanges face materially greater risks than on
equities markets, in view of the enormous number of individual option
series available for quoting on options markets, IEX believes that they
nonetheless provide relevant precedent for the risk management
protections that D-Limit orders would provide. Market participants on
both options and equities markets face significant challenges in
cancelling or adjusting resting orders during times of market
transition, in the face of other market participants engaged in
sophisticated latency arbitrage efforts.
---------------------------------------------------------------------------
\72\ See, e.g., NYSE Arca Rule 6.40-O; Nasdaq ISE, LLC Options
3, Section 15(a)(3)(B); Nasdaq GEMX, LCC Options 3, Section
15(a)(3)(B); Nasdaq MRX, LLC Options 3, Section 15(a)(3)(B); Miami
International Securities Exchange LLC (``MIAX'') Rule 519A; Nasdaq
Rule 6130; Market Maker Risk Management Information Sheet for Nasdaq
PHLX LLC (``Nasdaq PHLX'')/Nasdaq Options Market (``NOM'')/Nasdaq BX
available at https://www.nasdaq.com/docs/MarketMakerRiskManagement_PHLX_NOM_BX.pdf; and Order Risk Management
Information Sheet for Nasdaq PHLX/NOM/Nasdaq BX available at https://www.nasdaq.com/docs/OrderRiskManagement_PHLX_NOM_BX.pdf.
\73\ See ``CBOE Purge Ports Frequently Asked Questions''
available at https://cdn.cboe.com/resources/features/Cboe_USO_PurgePortsFAQs.pdf and MIAX Rule 519C.
---------------------------------------------------------------------------
Third, an example of implicit quote fading is the manner in which
other exchanges offer expensive, high-speed proprietary market data
feeds and connectivity products that sophisticated market participants
can leverage (along with predictive strategies) to not only target
resting orders at unstable prices but to cancel or adjust resting
orders more quickly than market participants not using such products
and strategies can access their resting orders. As a result, when the
market for a particular security is in transition, these sophisticated
market participants are often able to cancel resting orders before less
sophisticated market participants can access them.\74\
---------------------------------------------------------------------------
\74\ See, e.g., Malinova, Katya and Park, Andreas, ``Does High
Frequency Trading Add Noise to Prices?'' (April 17, 2017) at 5,
available at https://www.rsm.nl/fileadmin/home/Department_of
_Finance_VG5_/LQ2017/Malinova_Katya.pdf (``When someone trades
against their quotes on one venue, market makers rush to cancel
their quotes on the other venue; if the market maker is very fast,
it may be able to cancel the other quote before portions of a
presumed multi-market order reach the other venue.'').
---------------------------------------------------------------------------
Thus, the Exchange believes that D-Limit orders will operate in a
manner consistent with the ``firm quote'' requirements of Regulation
NMS Rule 602(b) \75\ and with existing order types, practices and
precedent for protected quotations under the Order Protection Rule, as
discussed above. D-Limit orders will be subject to execution at their
ranked and displayed price (if displayable) at the time an incoming
order reaches the Exchange for execution against the D-Limit order. Any
price adjustment that occurs must occur before that point in time. This
is similar to the EDGA displayed MidPoint Discretionary order type,
which is subject to price adjustment to a less aggressive displayed
price in response to NBBO changes. As a result, a displayed MidPoint
Discretionary order may not be available for execution at its
previously displayed price by the time an incoming order reaches the
exchange for execution. Although a D-Limit displayed order would be
adjusted to a less aggressive price than the NBBO, while a MidPoint
Discretionary order will be adjusted to a less aggressive price that
has become the same-side NBBO, in both cases the order is no longer
available for execution at its previously displayed price. Further,
options exchanges cancel quotes and displayed orders as a result of
automated risk management functionality or enable cancellation through
faster purge ports. In those
[[Page 72005]]
situations, an order or quote that was previously displayed may not be
available for execution by the time an incoming order reaches the
exchange engine for execution. Moreover, all resting displayed orders
may be unavailable in the event that another order or a cancel message
is actionable prior to an incoming order reaching the engine,
particularly when targeted by a sophisticated market participant
engaged in latency arbitrage. And, as noted above, D-Limit orders will
only be subject to price adjustment on average for 0.007% of the
trading day, while the frequency of order cancellation or non-
availability attributable to the existing exchange mechanisms and
practices is determined by each market participant and not subject to
any transparent limitations.
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\75\ See supra note 65.
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Further, IEX believes that displayed D-Limit orders would clearly
qualify as ``automated quotations'' and therefore ``protected
quotations'' under Regulation NMS, as discussed in the Purpose section.
This conclusion is supported by two key considerations. First, IEX will
not impose any delay on orders seeking to access D-Limit quotations
beyond that which the Commission has already approved as consistent
with the requirements for ``automated quotations.'' Second, adjusting
prices of D-Limit displayed orders when the CQI is on is consistent
with well-established precedent allowing other exchanges to
automatically adjust the prices of protected quotations based on
changes in overall market prices.
Under Rule 611 of Regulation NMS,\76\ ``trade-through'' protections
are extended to each protected bid or offer, which is defined in
relevant part as ``an automated quotation that is the best bid or best
offer of a national securities exchange.'' \77\ The term ``automated
quotation'' is defined as one that permits an incoming order to be
marked as immediate-or-cancel (``IOC'') and that ``immediately and
automatically'' executes an IOC order against the displayed quotation
up to its full size, cancels any unexecuted portion, transmits to the
sender a message indicating the action taken, and updates the quotation
to reflect a change to its material terms.\78\
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\76\ 17 CFR 242.611.
\77\ 17 CFR 242.600(b)(61)(iii).
\78\ 17 CFR 242.600(b)(4).
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In approving IEX's exchange application, in response to arguments
that federal securities regulations did not permit exchanges to impose
any intentional delay, however small, on access to protected
quotations, the Commission determined that IEX's 350 microsecond
``speed bump,'' which is applied to incoming and outbound messages, is
``well within the range of geographic and technological latencies that
market participants experience today'' and therefore is ``comparable
to--and even less than--delays attributable to other markets that
currently are included in the NBBO.'' \79\ The Commission thus
concluded that, because IEX's speed bump is de minimis, its displayed
quotes were immediately accessible and entitled to protected quotation
status.\80\
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\79\ See note 64 supra at 41161.
\80\ See note 64 supra at 41162.
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Access to D-Limit quotes will not be subject to any delay beyond
that to which all IEX's orders, displayed and non-displayed, are now
subject. Accordingly, all D-Limit quotes will be immediately accessible
under Regulation NMS.
Moreover, based on precedent, the fact that D-Limit displayed
orders are subject to automatic repricing based on changes in market
prices does not affect their status as protected quotations. For
example, as discussed above, EDGA has an approved Midpoint
Discretionary Order, which allows members to post displayed or non-
displayed liquidity at the NBBO with discretion to execute at prices
extending to and including the NBBO midpoint.\81\ This EDGA order type
automatically reprices the order based on changes in the NBBO
(including to a less aggressive price), which benefits market
participants that use the order type by helping to assure they are not
executed at ``stale'' prices as well as to provide an opportunity for
those orders to execute at a more aggressive NBBO when prices move in
that direction. Similarly, various exchanges, including IEX, have
received approval for ``market maker peg'' order types, which
automatically reprice orders to allow market makers to meet their
quoting obligations on those exchanges by automatically repricing those
orders to within a designated percentage away from the NBBO.\82\
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\81\ See note 66 supra.
\82\ See, e.g., IEX Rule 11.190(b)(13); Cboe BZX Rule
11.9(c)(15); Nasdaq Rule 4702(b)(7).
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All these order types allow an exchange to automatically reprice
resting orders based on determinations by the individual exchanges, in
reading price updates from all exchanges, that the NBBO has changed.
With respect to the automated quotation definition, a participant
seeking to access a Midpoint Discretionary Order or market maker peg
order displayed at any one time may fail to execute at that price if
the order has been repriced by the exchange in the time between the
transmission of the order and its receipt and processing by the
exchange's systems. The potential that this will occur depends on
various factors, including, among others, the distance between the
point where the sender transmits the order to the exchange's systems
and how quickly those systems update their understanding of the NBBO
relative to the speed at which they process orders to take liquidity.
Because the use of a de minimis delay does not affect the ability
of a displayed order to qualify as a protected quotation, there is no
reason it should lose that status because its price is adjusted
automatically by the exchange in response to changes in the NBBO, as is
the case with the EDGA Midpoint Discretionary Order or the Nasdaq
displayed discretionary order. IEX does not believe that there are any
material differences in this regard between repricing that occurs in
response to an exchange determining the NBBO has changed, and repricing
based on an exchange determining--pursuant to a transparent formula--
that the NBBO is likely in the process of changing. In either case, the
automatic change to the quote's price is explicitly intended to prevent
executions at the originally displayed price.
D-Limit orders are differentiated because they are explicitly
designed to prevent executions in small time increments when the CQI is
on. While this functionality discriminates against the use of trading
strategies with more complete and timely information about market
prices that intentionally seek to trade against resting orders during
these time periods at stale prices, IEX believes that the D-Limit
functionality is not unfairly discriminatory within the meaning of the
Act because it is a narrowly tailored means of protecting, and thereby
encouraging the use of, displayed quotations by both investors and
market makers. Moreover, for the reasons discussed in the Purpose
section, the Exchange believes that the proposed D-Limit order type may
result in market participants entering more displayed and other resting
limit orders on IEX, and at more aggressive prices, sizes and duration,
which would benefit all market participants and thereby further the
purposes of the Act.
Further, IEX believes that the specified order attributes for D-
Limit orders are consistent with the Act because they are structured to
facilitate efficient execution of D-Limit orders in a manner consistent
with existing functionality and order types.
[[Page 72006]]
Additionally, IEX believes that the proposal is consistent with
protection of investors and the public interest in that the D-Limit
order type is designed to assist Members in obtaining best execution
for their customers by providing an opportunity to execute at the NBBO,
but limiting executions at the NBBO when the NBBO appears to be
unstable, thereby reducing the potential to execute at an imminently
stale price.
In conclusion, IEX believes that the proposed new D-Limit order
type is consistent with the protection of investors and the public
interest purposes of the Act in that it is designed to protect
liquidity providers from certain adverse impacts of latency arbitrage
strategies, and thereby incentivize the entry of additional resting
orders, including displayed orders on the Exchange, thus enhancing
price discovery and the overall liquidity profile on the Exchange to
the benefit of all market participants.
B. Self-Regulatory Organization's Statement on Burden on Competition
IEX does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. To the contrary, the proposal
is designed to enhance IEX's competitiveness by incentivizing the entry
of increased liquidity. With regards to inter-market competition, other
exchanges are free to adopt similar order types to the extent that the
proposed changes pose a competitive threat to their business. In this
regard, the Exchange notes that NYSE American LLC (``NYSE Amex'')
previously adopted a rule copying an earlier iteration of the
Exchange's Discretionary Peg order type and quote stability
calculation.\83\
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\83\ See NYSE Amex Rule 7.31E(h)(3)(D).
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In addition, the Exchange believes that the proposed rule change
will enhance its ability to compete with alternative trading systems
(``ATSs''). In this regard, IEX believes that a meaningful segment of
market participants choose to rest orders on non-displayed ATSs in
order to obtain protection from latency arbitrage strategies. As
opposed to exchanges, ATSs can be structured to enable counter-party
selection so that participants can choose to avoid interacting with
certain counterparties deemed to be undesirable.\84\ The Exchange
believes that counter-party selection is important to some of these
market participants, in part to avoid being subject to adverse latency
arbitrage. While the proposed rule change will not enable counter-party
selection, IEX believes that to the degree it is successful in reducing
the impact of latency arbitrage strategies targeting resting orders at
stale prices, it may reduce the need for counter-party selection and
thereby incentivize such market participants to post displayed and
other limit orders on IEX. Accordingly, the Exchange also believes that
the proposed rule change will not result in any burden on inter-market
competition that is not necessary or appropriate in furtherance of the
purposes of the Act.
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\84\ See Securities Exchange Act Release No. 83663 (July 18,
2018), 83 FR 38768, 38853 (August 7, 2018).
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With regards to intra-market competition, D-Limit orders will be
available to all Members on a fair, impartial and nondiscriminatory
basis. While the proposed rule change is designed to provide certain
protections to limit orders, all Members are eligible to enter D-Limit
orders on the same terms and the protections will be available to all
Members on the same terms. Moreover, the Exchange does not believe that
the proposed change will result in any burden on Members seeking to
cross the spread and execute at the far side quote (the NBO (NBB) for
buy (sell) orders) or to Members seeking to conduct a market wide sweep
with intermarket sweep orders. D-Limit orders will only be subject to
potential adjustment for an extremely small percentage of the trading
day and the rest of the time will be available for execution, if
consistent with the order's limit price, at the far side quote. To the
extent that a D-Limit order is adjusted to a less aggressive price
while a Member is seeking to access the full displayed size of the
order at the prior more aggressive price with an intermarket sweep
order, the Member would be permitted to trade-through the D-Limit order
at the more aggressive price pursuant to Rule 611(b)(6) of Regulation
NMS.\85\ Moreover, the proposed change would provide potential benefits
to such Members to the extent there is more liquidity available on IEX
as a result of the protections provided to users of D-Limit orders. As
discussed above, the protections offered by the D-Limit order type, as
proposed, are intended in part to incentivize additional resting limit
orders to be entered on the Exchange, which would provide additional
available liquidity to all Members.
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\85\ Regulation NMS Rule 611(b)(6) provides an exception to its
trade-through requirements if the transaction that constituted the
trade-through was effected by a trading center that simultaneously
routed an intermarket sweep order to execute against the full
displayed size of any protected quotation in the NMS stock that was
traded through. See 17 CFR 242.611(b); see also Question 4.06 in
``Responses to Frequently Asked Questions Concerning Rule 611 and
610 of Regulation NMS'' (April 4, 2008), available at https://www.sec.gov/divisions/marketreg/nmsfaq610-11.htm.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission shall:
(a) By order approve or disapprove such proposed rule change, or
(b) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-IEX-2019-15 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-IEX-2019-15. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written
[[Page 72007]]
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for website viewing and printing in the Commission's Public
Reference Room, 100 F Street, NE, Washington, DC 20549 on official
business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of
the filing also will be available for inspection and copying at the
principal offices of the Exchange. All comments received will be posted
without change. Persons submitting comments are cautioned that we do
not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly. All submissions should refer to File Number SR-IEX-
2019-15, and should be submitted on or before January 21, 2020.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\86\
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\86\ 17 CFR 200.30-3(a)(12).
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J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2019-28024 Filed 12-27-19; 8:45 am]
BILLING CODE 8011-01-P