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Innovation Wave in US Equity Market Structure

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Nasdaq acquiring a stake in LeveL ATS indicates that a new wave of innovation in the US equity market structure is occurring according to Brad Bailey, research director in the capital markets division of consultancy Celent.

At the start of August Nasdaq announced it was buying a significant minority stake in LeveL ATS, an independent US equity dark pool trading venue which launched in 2006. Nasdaq joins Bank of America, Citi, and Fidelity as owners.

Whit Conary, chief executive of LeveL ATS, said in a statement: “In a rapidly changing market landscape, our independent operating model has given us the ability to scale and expand our product and service offerings. Having Nasdaq onboard provides us with an even greater runway for future growth, innovation and enhanced client experience.”

In June this year LeveL ATS launched three proprietary volume weighted average price order types – VWAP Block, VWAP Slice and VWAP Full Day.

Nasdaq’s deal follows Cboe Global Markets’ purchase of BIDS Trading, the largest independent block trading alternative trading system in the US, which completed at the start of this year and TP ICAP completing its acquisition of dark pool Liquidnet in March this year.

Bailey said there are significant reasons why firms are rethinking their venue ownership and the products they can offer to different segments of the market.

“There’s a lot of potential for change,” he added. “People are not sure where things are going and they want to make sure they are positioned for new market structure releases and changes.”

New technology and new leadership at the US Securities and Exchange Commission have brought market structure debates to the fore. Gary Gensler, chair of the SEC, has said in speeches that he has asked the regulator’s staff to consider the impact that technology has made in fixed income and equity markets.

“We are seeing a new wave of innovation in marketplaces and people are placing bets,” added Bailey.

New venues have entered the market. Three exchanges launched in the US in 2020 – Members Exchange (MEMX), MIAX Pearl Equities and Long Term Stock Exchange (LTSE) – taking the total to 16.

In addition new US alternative trading systems have launched including PureStream Trading Technologies which allows institutions to trade blocks algorithmically; Blue Ocean Technologies which facilitates the trading of US listed equities in overnight hours; OneChronos which matches counterparties using mathematical optimization; and IntelligentCross that uses artificial intelligence to match orders.

Off-exchange trading

Gensler has also highlighted in speeches that nearly half, 47%, of US trading volume is not displayed on lit markets but executed by ATSs and by off-exchange wholesalers.

“Thus, significant trading interest on these platforms is not necessarily being reflected in the commonly cited National Best Bid and Offer quote,” said Gensler. “I’ve asked staff to consider whether this equity market structure, as currently composed, best promotes efficiency and competition.”

In the US retail trades are not executed on exchanges but most are sold to market makers under “payment for order flow” agreements. The market makers internalize the flow and capture the majority of the spread, in return for offering retail investors a slight improvement on the exchange price.

The increase in retail trading volumes has also contributed to the rise in off-exchange volumes.

“I’ve asked SEC staff to consider the practice known as payment for order flow,” Gensler added. “We’ve seen a notable rise in payment for order flow in the U.S., something that you’ve banned in the United Kingdom. Canada and Australia also don’t allow broker-dealers to route retail orders to wholesalers in return for payments.”

Shane Swanson, equities and financial technology expert in Coalition Greenwich’s market structure and technology practice, said in a blog that off-exchange trading volumes, shown by data from Trade Reporting Facilities (TRFs), has grown from 34.49% of overall average daily volume in 2017 to 44.29% in the first half of this year.

Swanson continued that the vast majority of trading off-exchange occurs with the market makers.

“That said, we do see an anticipated increase in [dark pool] usage over the next three years across all sizes of institution participants,” he added. “We also see a relatively large increase in the use of low touch/algorithmic access.”

The blog said that both BIDS and Liquidnet have ranked highly on the consultancy’s scale of “uniqueness” for liquidity, and LeveL has been hitting record volume numbers according to  Coalition Greenwich data.

“In each case, these buyers are hoping to gain the precious commodities of additional flow and synergies,” added Swanson. “An increase in low touch and algo trading may forecast an increased appetite for the crossing opportunities that ATSs have in their DNA.”