Direct Edge, the US electronic stock exchange, is adopting new measures to combat high rates of quotes that do not result in trades, following measures by several other US and European groups to address the costs of such trading.
Like many exchanges, Direct Edge has seen an explosion of message traffic resulting from the increasing speed and use of high-frequency trading algorithms, many of which will quote and then cancel trades once they detect how the market is moving.
Though the practice is viewed by many as necessary to providing liquidity at low risk, enabling tight trading spreads, there is a growing belief that a portion of such traffic is inefficient, and possibly abusive as well.
It also drives up costs to many traders who do not trade in millisecond increments but must pay for such data feeds. Nanex, the market data firm, has said that many high-volume US trading days can produce nearly 1 terabyte, or a million megabytes, of data.
“These changes have had a profound impact on how our market operates, how resources are used, and the nature of responsible market participation,” said Bryan Harkins, chief operating officer, in a letter to clients.
To combat this, Direct Edge told clients on Wednesday it will start paying lower rebates on excessive volumes of messages, termed the Message Efficiency Incentive Program.
It will pay full rebates to eligible traders only if their average monthly ratio of messages-to-trades is at or less than 100 to 1. If they exceed that level, traders will receive $0.0001, or 1 mil, less per share in rebates.
“The objective of the [programme] is to continue to provide members with order-management flexibility, while acknowledging the benefits to the market that come with more efficient participation,” Mr Harkins wrote.
The flat approach is in keeping with moves at Deutsche Börse and Borsa Italiana, who have announced similar measures in recent weeks.
They were responding in part to regulatory concern. In Europe, several countries are considering transaction taxes that would affect all trading, but most dramatically high-speed strategies that produce tiny margins across thousands of trades.
The US is not looking at such blunt measures, but the Securities and Exchange Commission and Commodity Futures Trading Commission have both said they were still reviewing automated trading strategies. The CFTC cited “potential market disruptions”.
Some exchanges are focused on narrower excesses. Last week, the IntercontinentalExchange announced a year-long pilot programme that penalised high cancellation rates, but only when quotes were far away from the current market price.
It said that violations of its limits fell by 97 per cent, as firms adjusted their automated algorithms.
Other exchanges have also been tweaking their approaches to such traffic. The London Stock Exchange has operated a similar tariff, which it calls an “order management surcharge” since 2005 and revised it in 2010. Euronext, which comprises the Paris, Amsterdam, Brussels and Lisbon markets, has operated one since 2007.
Nasdaq OMX last year instituted rules requiring the minimum life for a quote on its PSX market. BATS recently adopted a market-making programme for shares that go public on its nascent listings market, whereby traders will be rewarded for effective quote rates.
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