81 FR 65442 - Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Notice of Filing of Proposed Rule Change To Adopt the CHX Liquidity Taking Access Delay
SECURITIES AND EXCHANGE COMMISSION
Federal Register Volume 81, Issue 184 (September 22, 2016)
Page Range
65442-65458
FR Document
2016-22790
Federal Register, Volume 81 Issue 184 (Thursday, September 22, 2016)
[Federal Register Volume 81, Number 184 (Thursday, September 22, 2016)]
[Notices]
[Pages 65442-65458]
From the Federal Register Online [www.thefederalregister.org]
[FR Doc No: 2016-22790]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-78860; File No. SR-CHX-2016-16]
Self-Regulatory Organizations; Chicago Stock Exchange, Inc.;
Notice of Filing of Proposed Rule Change To Adopt the CHX Liquidity
Taking Access Delay
September 16, 2016.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given
that on September 6, 2016, the Chicago Stock Exchange, Inc. (``CHX'' or
``Exchange'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II
and III 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\ 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
CHX proposes to amend the Rules of the Exchange (``CHX Rules'') to
adopt the CHX Liquidity Taking Access Delay. The text of this proposed
rule change is available on the Exchange's Web site at http://www.chx.com/rules/proposed_rules.htm, 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 those statements may be examined at
the places specified in Item IV below. The Exchange has prepared
summaries, set forth in sections A, B and C below, of the most
significant parts of such statements.
[[Page 65443]]
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
Background
The Exchange proposes to adopt the CHX Liquidity Taking Access
Delay (``LTAD''). LTAD is designed to neutralize microsecond speed
advantages exploited by low-latency market participants engaged in
latency arbitrage \3\ strategies that diminish displayed liquidity and
impair price discovery in national market system (``NMS'')
securities.\4\ In sum, LTAD would require all new incoming orders \5\
received during the Open Trading State \6\ that could immediately
execute against one or more resting orders on the CHX book, as well as
certain related cancel messages, to be intentionally delayed for 350
microseconds before such delayed messages would be processed \7\ by the
Matching System.8 9 All other messages, including liquidity
providing orders (i.e., orders that would not immediately execute
against resting orders) and cancel messages for resting orders, would
be immediately processed without delay. LTAD will not delay any
outbound messages or market data.
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\3\ As used herein, ``latency arbitrage'' means the practice of
exploiting disparities in the price of a security or related
securities that are being traded in different markets by taking
advantage of the time it takes to access and respond to market
information. Given its emphasis on speed, latency arbitrage has
resulted in a well-documented and escalating technology race among
certain market participants seeking to obtain ever smaller speed
advantages. See Eric Budish, Peter Cramton and John Shim, ``The
High-Frequency Trading Arms Race: Frequent Batch Auctions as a
Market Design Response,'' Quarterly Journal of Economics, Vol.
130(4), November 2015 (``Budish Paper''); see also e.g., Elaine Wah
and Michael Wellman. 2013. ``Latency Arbitrage, Market
Fragmentation, and Efficiency: A Two-Market Model.'' 14th ACM
Conference on Electronic Commerce, June. In recent years, a
significant amount of academic research has been done regarding the
impact of latency arbitrage on the efficiency of securities markets.
See id. Many of these studies have suggested that latency arbitrage
exacts a ``tax'' on liquidity provision that dissuades liquidity
providers from displaying large aggressively priced orders for fear
of their stale orders being taken by latency arbitrageurs before the
liquidity providers have had the chance to adjust such orders when
reacting to the same market data. See Eric Budish, Comment letter
regarding ``Investors' Exchange LLC Form 1 Application (Release No.
34-75925; File No. 10-222)'' dated February 5, 2016 (``Budish
Letter'').
\4\ The Exchange notes that while LTAD is designed to neutralize
microsecond speed advantages, liquidity providers would still be
required to obtain speed capabilities fast enough to take advantage
of the LTAD.
\5\ ``New incoming orders'' are orders received by the Matching
System for the first time. As discussed below, LTAD will not apply
to other situations where existing orders or portions thereof are
treated as incoming orders, such as (1) resting orders that are
price slid into a new price point pursuant to the CHX Only Price
Sliding or Limit Up-Limit Down Price Sliding Processes and (2)
unexecuted remainders of routed orders released into the Matching
System. See CHX Article 1, Rule 2(b)(1)(C); see also CHX Article 20,
Rule 2A(b); see also CHX Article 20, Rule 8(b)(7). Incidentally, the
Exchange is proposing to amend CHX Article 20, Rule 8(a)(7), which
describes how unexecuted remainders of routed orders are handled by
the Matching System, to delete the word ``new'' from the last
sentence, so that the rule provides, in pertinent part, that if no
balance exists at the time a part of an unexecuted remainder of a
routed order is returned to the Matching System, it shall be treated
an incoming order.
\6\ See CHX Article 1, Rule 1(qq) defining ``Open Trading
State.''
\7\ For ease of reference, ``processed'' means executing
instructions contained in a message, including, but not limited to,
permitting an order to execute within the Matching System pursuant
to the terms of the order or cancelling an existing order, whereas
``evaluate'' means the Matching System determining whether a message
should be diverted into LTAD, as described below.
\8\ The Matching System is an automated order execution system,
which is a part of the Exchange's ``Trading Facilities,'' as defined
under CHX Article 1, Rule 1(z).
\9\ As discussed below, the Exchange submits that LTAD is a de
minimis intentional access delay in that it is so short as to not
frustrate the purposes of Rule 611 of Regulation NMS by impairing
fair and efficient access to an exchange's quotations. See
Securities Exchange Act Release No. 78102 (June 17, 2016), 81 FR
40785 (June 23, 2016) (``Final Interpretation''). Thus, the
Exchange's quotations would continue to be ``immediately''
accessible and protected pursuant to Rule 611. See 17 CFR
242.600(b)(3) defining ``automated quotation''; see also 17 CFR
242.600(b)(58) defining ``protected quotation''; see also infra
Section 3(b).
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LTAD is a direct response to recent declines in CHX volume and
liquidity in the SPDR S&P 500 trust exchange-traded fund (``SPY''),\10\
which the Exchange attributes to latency arbitrage activity in SPY
first observed at CHX in January 2016 (``SPY latency arbitrage
activity'').\11\ Specifically, based on its review of unusual messaging
patterns in SPY during the relevant period, corroborating Participant
feedback and analysis of market data,\12\ the Exchange believes that
SPY latency arbitrage has caused CHX liquidity providers to
dramatically reduce displayed liquidity in SPY (and at times withdraw
from the market altogether), which, given CHX's significant
contribution to overall volume and liquidity in SPY prior to the
declines,\13\ materially decreased liquidity in SPY marketwide, as
discussed below.\14\
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\10\ The Exchange believes that much of the CHX liquidity in SPY
and other S&P 500-correlated securities is provided as part of an
arbitrage strategy between CHX and the futures markets, whereby
liquidity providers utilize, among other things, proprietary
algorithms to price and size resting orders on CHX to track index
market data from a derivatives market (e.g., E-Mini S&P traded on
the Chicago Mercantile Exchange's Globex trading platform). As such,
an exchange could not make related adjustments to these special
orders on behalf of liquidity providers pursuant to an order type,
such as pegged orders benchmarked to the NBBO. Compare infra note
16.
\11\ As discussed in detail under Appendix A below, prior to the
beginning of the SPY latency arbitrage activity in January 2016, CHX
volume and liquidity in SPY constituted a material portion of
overall volume and liquidity in SPY marketwide. For example, the CHX
Market Share in SPY as a percentage of Total Volume decreased from
5.73% in January 2016 to 0.57% in July 2016, while the Control
Securities did not experience similar declines. See infra note 12;
see also infra Appendix A; see also infra Appendix B Calculation Set
1a. Also, the Time-weighted Average CHX Size At The NBBO in SPY
relative to the total NMS Size At The NBBO in SPY decreased from
44.36% in January 2016 to 3.39% of the total NMS Size At The NBBO in
SPY in July 2016, while the Control Securities did not experience
similar declines. See infra note 12; see also infra Appendix A; see
also infra Appendix B Calculations Sets 3a and 4a.
\12\ A detailed analysis (``CHX ETF Analysis'') of the impact of
latency arbitrage on displayed liquidity in SPY at CHX, for the
period of August 2015 through July 2016 (``Analysis Period''), may
be found under Appendix A. The market data utilized by the CHX ETF
Analysis, as well as defined terms and notes, may be found under
Appendix B.
\13\ See supra note 11.
\14\ See infra Appendix A.
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The Exchange believes that the best way to minimize the
effectiveness of latency arbitrage strategies on CHX with respect to
resting limit orders is to implement an asymmetric delay, such as LTAD,
to deemphasize speed as a key to trading success.\15\ By delaying
liquidity taking orders, and not delaying liquidity providing orders
and related adjustment messages, LTAD would give liquidity providers a
small amount of additional time, the same length as the Investors
Exchange LLC (``IEX'') POP/coil delay (``IEX Delay'') recently approved
by the Commission,\16\ to cancel or adjust resting orders on the CHX
book to comport to the most recent market data before latency
arbitrageurs could take such orders at potentially ``stale''
prices.\17\ As the Commission noted in the IEX Approval Order, a
symmetric delay that delays all inbound messages, such as the IEX
Delay, would be ineffective in protecting resting limit
[[Page 65444]]
orders from latency arbitrage.\18\ Thus, the Exchange believes that
LTAD will enhance displayed liquidity and price discovery in NMS
securities without adversely affecting the ability of virtually all
market participants, other than latency arbitrageurs, to access
liquidity at CHX.\19\
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\15\ See Mary Jo White, Chair, Securities and Exchange
Commission, Speech at Sandler O'Neil & Partners L.P. Global Exchange
and Brokerage Conference (June 5, 2014).
\16\ See Securities Exchange Act Release No. 78101 (June 17,
2016), 81 FR 41141 (June 23, 2016) (``IEX Approval Order''). Unlike
LTAD, the IEX Delay will delay all inbound order-related messages
from IEX Users, outbound message confirmations to IEX Users, and
outbound market data disseminated through IEX's proprietary data
feed. See IEX Approval Order at 41154. By not delaying inbound
market data, IEX would be able to reprice its resting pegged orders
to track changes to the NBBO before latency arbitrageurs could
execute against such pegged orders at potentially stale prices,
which facilitates the ability of IEX to comply with its rules
regarding the repricing of pegged orders. See IEX Approval Order at
41155.
\17\ In discussing possible alternatives to a frequent batch
auction model for trading securities, the Budish Paper provides that
``the asymmetric delay eliminates sniping and stops the arms race.''
See Budish Paper at 1612.
\18\ See IEX Approval Order, supra note 16, at 41157.
\19\ Based on the Exchange's analysis of cancel activity in SPY
at CHX for the period starting in May 2016 through July 2016, the
Exchange believes that if LTAD had been implemented during that time
period, out of a total of 18,316 partially-executed orders in SPY,
20 liquidity taking orders not attributed to latency arbitrage
activity would have not been executed, a de minimis number in the
light of the enhanced liquidity and price discovery afforded by
LTAD. See infra Appendix C.
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Additionally, the Exchange notes that adopting a symmetric delay
and order types that would permit the Exchange to reprice resting
orders based on undelayed market data (e.g., pegged orders), such as
the IEX Delay, would not be practical in addressing latency arbitrage
with respect to limit orders because the liquidity provision strategies
utilized by CHX liquidity providers in SPY, which provide valuable
liquidity to the market overall,\20\ require cancellations or
adjustments to resting limit orders pursuant to proprietary algorithms
held by the CHX liquidity providers that could not be adequately
replicated by CHX.\21\
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\20\ See supra note 12; see also infra Appendices A and B.
\21\ See supra note 10.
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In light of the above, the Exchange submits that the proposed rules
for LTAD are designed to operate in a manner that is consistent with
the Act in that they are designed to protect investors and the public
interest, are not designed to permit unfair discrimination, and would
not impose any unnecessary or inappropriate burden on competition.\22\
The Exchange now proposes the following amendments to the CHX Rules to
implement LTAD.
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\22\ See infra Section 3(b).
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Amended Article 20, Rule 8 (Operation of the CHX Matching System)
Proposed Article 20, Rule 8(h) provides rules that comprehensively
describe LTAD. Specifically, proposed paragraph (h) begins by stating
that after initial receipt \23\ of a new incoming message, the Matching
System will evaluate \24\ the message to determine whether it is a
``delayable message,'' as defined under proposed paragraph (h)(1)
below. For the purposes of such an evaluation only, the Matching System
shall not consider Match Trade Prevention (``MTP''), as described under
current Article 1, Rule 2(b)(3)(F).\25\ If not delayable, the Matching
System will immediately process the message without delay. Proposed
paragraph (h)(1) defines ``delayable message'' and provides that
delayable messages shall only include the following:
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\23\ As used herein, ``initial receipt'' means the time at which
the Exchange receives a message and assigns the message a unique
sequence number, which the Exchange utilizes to determine, among
other things, message processing order and ranking on the CHX book.
See CHX Article 20, Rule 8(b).
\24\ See supra note 7.
\25\ The purpose of ignoring MTP in LTAD evaluation is to
provide a previously delayed order that would not have triggered MTP
an opportunity to execute against the resting order before the newer
incoming order would cancel the resting order after release from
LTAD. The Exchange is proposing unrelated modifications to MTP to
contemplate LTAD, as discussed below.
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(A) New incoming orders received during the Open Trading State \26\
that would take liquidity from the CHX book.
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\26\ The Exchange notes that LTAD would not apply during a SNAP
Cycle, as described under CHX Article 18, Rule 1, as orders are not
immediately executable at that time.
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(B) Cancel and cancel/replace messages for delayed orders that have
not yet been released from LTAD.\27\
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\27\ As noted later under proposed paragraph (h), a delayed
message may only be delayed once and, thus, the replace portion of a
delayed cancel/replace message shall not be diverted into LTAD upon
release in the event that it would take liquidity from the CHX book.
(C) The replace portion of a cancel/replace message where the
cancel portion cancels a resting order and the replace portion would
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take liquidity from the CHX book.
The Exchange notes that the purpose of delaying the aforementioned
cancel and cancel/replace messages is to minimize gaming opportunities
by requiring the delayed order to interact with the CHX book before it
is eligible for cancellation.
Mechanically, upon initial receipt of a new incoming message, the
Matching System would assign the message a unique sequence number, as
it does currently, which, in addition to establishing processing and
execution priority, will serve as the starting point for the Fixed LTAD
Period, as described below. The Matching System would then initially
evaluate the message to determine whether it is a delayable
message.\28\ For example, a new incoming limit order marked Post Only
\29\ that could not take liquidity from the CHX book would not be a
delayable message because it could not immediately execute against one
or more resting orders on the CHX book. In such a case, the undelayed
Post Only order would be immediately cancelled by the Matching System
if it would immediately match with a resting order. Similarly, a new
incoming order marked CHX Only \30\ that would trade-through a
protected quotation of an external market would not be a delayable
message as it would be price slid to a permissible price.\31\ However,
a new incoming order that could immediately execute against a resting
order, but for the fact that MTP would be triggered and prevent a
match, would be considered a delayable message, as MTP is ignored for
the purposes of LTAD evaluation only.\32\
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\28\ The Exchange notes that the Matching System processes
messages for a given security serially. Thus, the length of time it
takes for a message to be evaluated and/or processed by the Matching
System after initial receipt is herein called ``variable message
queuing delay,'' as the actual length of the delay depends on the
number of precedent messages that have yet to be evaluated and/or
processed by the Matching System and are residing in the ``Inbound
Queue.'' The length of time it takes for a message to be evaluated
and/or processed by the Matching System is herein called ``system-
processing delay.''
\29\ See CHX Article 1, Rule 2(b)(1)(D) defining ``Post Only.''
\30\ See CHX Article 1, Rule 2(b)(1)(C) defining ``CHX Only.''
\31\ See CHX Article 20, Rule 5(a)(2).
\32\ See supra note 25.
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Proposed paragraph (h) continues by providing that if a message is
delayable, the message will be diverted into the LTAD queue and will
remain delayed until it is released for processing. A delayed message
shall become releasable 350 microseconds after initial receipt by the
Exchange (``Fixed LTAD Period''),\33\ but shall only be processed after
the Matching System has evaluated and processed, if applicable,\34\ all
messages in the security received by the Exchange during the Fixed LTAD
Period for the delayed message. Thus, a message may be delayed for
longer than the Fixed LTAD Period depending on the then-current
messaging volume in the security.\35\ The Matching System
[[Page 65445]]
will utilize a new market snapshot to process a released order.\36\
Also, a delayed message shall retain its original sequence number and
may only be delayed once. In addition, LTAD shall apply to all
delayable messages submitted by any Participant for a security traded
on the Exchange that is subject to LTAD. The Exchange may activate or
deactivate LTAD per security with notice to Participants.\37\
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\33\ In the event that then-current messaging volume results in
a delayable message being evaluated after 350 microseconds from
initial receipt, the delayable message shall be diverted into LTAD
and be immediately releasable. This will ensure that messages
received during the Fixed LTAD Period for a delayed message are
evaluated and processed, if applicable, before the delayable message
is released.
\34\ For example, an order that could not take liquidity from
the CHX book would not be delayed and would be immediately
processed, whereas an order that could take liquidity from the CHX
book would be delayed and would not be immediately processed.
\35\ In the event a releasable message is awaiting other
messages received during its Fixed LTAD Period to be evaluated and
processed, if applicable, the releasable message would be subject to
an additional unintentional variable delay that is a function of the
then-current messaging volume in the security. See supra note 28;
see also supra note 33; see also infra Examples 1-3.
\36\ The purpose of a new market snapshot is to ensure that the
released order is processed in a manner consistent with federal
securities rules and regulations, such as Regulation NMS and
Regulation SHO.
\37\ As of the date of this filing, the Exchange anticipates
applying LTAD to all securities traded on CHX. In the event the
Exchange decides to activate or deactivate LTAD for certain
securities, the Exchange will communicate the list of securities for
which LTAD will be applied and/or the securities for which LTAD will
not be applied, as well as the effective date(s) of such change(s),
through a Customer Service Notification. Any change to the list of
LTAD securities shall not be effective prior to the trading day
following the date of the Customer Service Notification and shall
only be effective as of the beginning of the relevant trading day.
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The Exchange also proposes to make corresponding amendments to
current Article 20, Rule 8(d) and (f) to contemplate LTAD.
Specifically, the Exchange proposes to add the clause ``subject to
paragraph (h) below'' at the end of current paragraph (d)(1) so that
amended paragraph (d)(1) provides as follows:
Except for certain orders which shall be executed as described
in Rule 8(e), below, an incoming order shall be matched against one
or more resting orders in the Matching System, in the order in which
the resting orders are ranked on the CHX book, pursuant to Rule 8(b)
above, at the Working Price of each resting order, as defined under
Article 1, Rule 1(pp), for the full amount of shares available at
that price, or for the size of the incoming order, if smaller;
subject to paragraph (h) below.
The Exchange also proposes to adopt paragraph (f)(3) to provide that
certain cancel messages for an order in LTAD shall be handled as
described under proposed paragraph (h). Incidentally, the Exchange
proposes to replace the semi-colon and the word ``and'' at the end of
current paragraph (f)(1) with a period.
Moreover, proposed paragraph (h)(2) describes how LTAD would
interact with the Exchange's current order routing protocol and
provides that the portion of a Routable Order \38\ that is to be routed
away, pursuant to current Article 19, Rule 3(a), shall be immediately
routed without delay; provided that the entire unrouted balance of the
Routable Order will be diverted into LTAD upon reaching the price point
at which the unrouted balance of the Routable Order would become a
delayable message (i.e., would take liquidity from the CHX book),
pursuant to proposed paragraph (h)(1)(A).
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\38\ See CHX Article 1, Rule 1(oo).
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Currently, the Exchange determines where and how to route an order
on a price point-by-price point basis.\39\ That is, the Exchange does
not aggregate all protected quotations and resting liquidity through
multiple price points in making a single order routing decision.\40\
Thus, to the extent that an incoming order could take liquidity from
the CHX book at a price worse than an away protected quotation (e.g.,
incoming sell order at $10.00/share; CHX Best Bid at $10.00/share and
NBB at $10.01/share), the Matching System would not consider the fact
that the incoming order could take liquidity from the CHX book at the
time the Matching System is evaluating the better priced protected
quotation. As such, LTAD may result in a portion of a Routable Order
being immediately routed away and the unrouted remainder being delayed.
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\39\ See Exchange Act Release No. 74487 (March 12, 2015), 80 FR
14193 (March 18, 2015) (SR-CHX-2015-02).
\40\ See id.
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Amended Routing Protocol
In light of the possible bifurcation of a Routable Order into an
immediately routed portion and a delayed unrouted portion and the fact
that the Exchange does not currently utilize any Router Feedback \41\
to augment protected quotations,\42\ LTAD could result in a single
order being routed twice to satisfy the same protected quotation. In
order to eliminate this inefficiency, the Exchange proposes to amend
its current order routing protocol to adopt a single type of Router
Feedback called Immediate Feedback to be applied on an order-by-order
basis only.\43\
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\41\ ``Router Feedback'' refers to the use of routed orders
(``Feedback Orders'') to augment protected quotations for the
purposes of calculating the NBBO. See Securities Exchange Act
Release No. 74075 (January 15, 2015), 80 FR 3693 (January 23, 2015)
(SR-BYX-2015-03).
\42\ The consolidated market data disseminated by the securities
information processors (``SIPs'') are the only market data feeds
utilized by the Exchange for the handling, execution and routing of
orders, as well as for the regulatory compliance processes related
to those functions. See CHX Article 1, Rule 4. Also, the Exchange
does not currently ignore or modify SIP quote data for away markets
under any circumstances where the SIP data feed shows an uncrossed
market. See Exchange Act Release No. 74357 (February 24, 2015), 80
FR 11252 (March 2, 2015) (SR-CHX-2015-01); see also Securities
Exchange Act Release No. 72711 (July 29, 2014), 79 FR 45570 (August
5, 2014) (SR-CHX-2014-10).
\43\ Bats BYX utilizes three different types of Router Feedback
in its calculation of the NBBO, which includes Immediate Feedback,
which is described as follows: ``Where BATS Trading routes an order
to a venue with a protected quotation using Smart Order Routing (a
``Feedback Order''), the number of shares available at that the
venue is immediately decreased by the number of shares routed to the
venue at the applicable price level.'' See SR-BYX-2015-03, supra
note 41, at 3695. Also, all Feedback expires as soon as: (i) One
second passes; (ii) the exchange receives new quote information; or
(iii) the exchange receives updated Feedback information. See id.
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Specifically, Immediate Feedback would permit the Exchange's
Routing System to decrease the number of shares available at an away
market by an amount equal to the size of the immediately routed portion
of the Routable Order, on an order-by-order basis, with such feedback
expiring as soon as: (i) One second passes or (ii) the Exchange
receives new quote information from the away market.\44\ This would
permit the Exchange to utilize Immediate Feedback to ignore the
protected quotation to which the immediately routed portion was routed
when the unrouted delayed portion is released from LTAD, thereby
preventing double routing to satisfy the same protected quotation.\45\
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\44\ Given the length of the Fixed LTAD Period, the Exchange
notes that it is unlikely that Immediate Feedback would expire due
to one second passing without new quote information.
\45\ Given the length of the Fixed LTAD Period, it is unlikely
that the Exchange would receive a confirmation from the away market
prior to the unrouted delayed portion being released from LTAD.
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Examples 1-3 illustrate the operation of LTAD. Examples 3 and 4
illustrate the operation of the proposed amended routing protocol.
Amended Article 1, Rule 2(b)(3)(F) (Match Trade Prevention)
Current Article 1, Rule 2(b)(3)(F) describes the MTP modifier,
which prevents matches between orders that originate from the same MTP
Trading Group or MTP sublevel thereunder.\46\ Also, an order sender
must designate one of the following MTP Actions for each order, with
the MTP Action noted on the incoming order controlling the MTP
interaction:
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\46\ See Securities Exchange Act Release No. 71216 (December 31,
2013), 79 FR 883 (January 7, 2014) (SR-CHX-2013-23); see also
Securities Exchange Act Release No. 70948 (November 26, 2013), 78 FR
72731 (December 3, 2013) (SR-CHX-2013-20).
MTP Cancel Incoming (``N''): An incoming limit or market order
marked ``N'' will not execute against opposite side resting interest
originating from the same MTP Trading Group or MTP sublevel, if
applicable. Only the incoming order will be cancelled pursuant to
MTP.
MTP Cancel Resting (``O''): An incoming limit or market order
marked ``O'' will not execute against opposite side resting interest
originating from the same MTP Trading
[[Page 65446]]
Group or MTP sublevel, if applicable. Only the resting order will be
cancelled pursuant to MTP.
MTP Cancel Both (``B''): An incoming limit or market order
marked ``B'' will not execute against opposite side resting interest
originating from the same MTP Trading Group or MTP sublevel, if
applicable. The entire size of both orders will be cancelled
pursuant to MTP.
Given that LTAD may result in newer orders (i.e., orders with lower
sequence numbers) becoming resting orders prior to older orders being
released from LTAD,\47\ the Exchange proposes to amend current Article
1, Rule 2(b)(3)(F)(iii)(a) and (b), which describe MTP Actions ``N''
and ``O'' respectively, to provide that the newer of the contra-side
orders, as opposed to the incoming order if it is the older order,
would be cancelled if the incoming order is marked ``N,'' and the older
of the contra-side orders, as opposed to the resting order if it is the
newer order, would be cancelled if the incoming order is marked ``O.''
Moreover, given that a price slid order that triggers MTP is not always
the newer order \48\ and because the Exchange wishes to maintain the
current handling of MTP when it is triggered by a price slid order, the
Exchange proposes to add clauses to the end of current subparagraphs
(a) and (b) that preserve that current handling. Thus, amended
subparagraphs (a) and (b) provide as follows:
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\47\ Currently, a new incoming order that triggers MTP is always
newer than the resting contra-side order. However, LTAD may result
in the newer of the contra-side orders being the resting order and
the older order being the incoming order. See infra Example 5.
\48\ See Example 4 under SR-CHX-2013-20.
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(a) MTP Cancel New (``N''): An incoming limit or market order
marked ``N'' will not execute against opposite side resting interest
originating from the same MTP Trading Group or MTP sublevel, if
applicable. Only the newer order will be cancelled pursuant to MTP;
provided that the incoming order will be cancelled, even if it is not
the newer order, in the event MTP is triggered by the incoming order
being price slid pursuant to the CHX Only Price Sliding Processes.
(b) MTP Cancel Old (``O''): An incoming limit or market order
marked ``O'' will not execute against opposite side resting interest
originating from the same MTP Trading Group or MTP sublevel, if
applicable. Only the older order will be cancelled pursuant to MTP;
provided that the resting order will be cancelled, even if it is not
the older order, in the event MTP is triggered by the incoming order
being price slid pursuant to the CHX Only Price Sliding Processes.
Example 5 below illustrates how the amended MTP would operate in
the context of LTAD.
Examples
The following Examples are illustrative of LTAD and related
amendments to existing functionality, but do not exhaustively depict
every possible scenario that may arise under LTAD. Moreover, the
Examples do not necessarily depict the actual technical processes of
prioritizing messages and executing orders.
Example 1: LTAD. Assume that LTAD is operational, all messages are
for security XYZ and all orders are routable. Assume that the system-
processing delay \49\ is 50 microseconds.\50\ Assume then at
9:59:59.999999, the NBBO is 10.00 x 10.01, the Inbound Queue and the
LTAD queue are empty and the CHX book is as follows:
---------------------------------------------------------------------------
\49\ See supra note 28.
\50\ The Exchange does not represent that actual system-
processing delay is at or near 50 microseconds or that unintentional
delays do not exist elsewhere in the Matching System processes. The
figure is being utilized for demonstrative purposes only.
Fig 1a--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Empty..................................... Order A: 1000 @10.01.
------------------------------------------------------------------------
Assume then that at 10:00:00.000000, the Exchange receives the
following order:
Fig 1b--Inbound Queue
------------------------------------------------------------------------
Initial receipt Message
------------------------------------------------------------------------
10:00:00.0000000.......................... Order B: Buy 1000 @10.01.
------------------------------------------------------------------------
Under this Example 1, Order B would be immediately evaluated and
diverted into LTAD because it is a delayable message as it could
execute against Order A. Due to the system-processing delay, Order B
would be diverted into LTAD at 10:00:00.000050 and releasable at
10:00:00.000350. The result is that the Inbound Queue would be empty
and the LTAD queue would be as follows:
Fig 1c--LTAD Queue
------------------------------------------------------------------------
Releasable time Message
------------------------------------------------------------------------
10:00:00.000350........................... Order B: Buy 1000 @10.01.
------------------------------------------------------------------------
Example 2: Execution Priority. Assume the same as Example 1 and the
NBBO is still 10.00 x 10.01 with CHX being the only market at the NBO.
Assume then that the Matching System receives the following new
messages in security XYZ:
Fig 2a--Inbound Queue
------------------------------------------------------------------------
Initial receipt Message
------------------------------------------------------------------------
10:00:00.000265........................... Cancel Order A.
10:00:00.000305........................... Order C: Sell 1000 @10.02.
10:00:00.000310........................... Order D: Buy 1000 @10.01.
10:00:00.000325........................... Cancel Order B.
10:00:00.000355........................... Order E: Sell 1000 @10.01.
------------------------------------------------------------------------
Under this Example 2:
Cancel Order A would be evaluated and processed at
10:00:00.000265 without being diverted into LTAD as it would cancel a
resting order and is not a delayable message. However, due to the
system-processing delay, Order A would actually be cancelled at
10:00:00.000315 and the CHX book would become empty.
Order C would then be evaluated at 10:00:00.000315, due to
the variable message queuing delay,\51\ and then immediately processed
without being diverted into LTAD as it adds liquidity to the CHX book
and it is not a delayable message. However, due to the system-
processing delay, Order C would actually post to the CHX book at
10:00:00.000365 and the CHX book would be as follows:
---------------------------------------------------------------------------
\51\ See supra note 28.
Fig 2b--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Empty..................................... Order C: 1000 @10.02.
------------------------------------------------------------------------
While Order C was being evaluated and processed by the
Matching System, Order B became releasable from the LTAD queue at
10:00:00.000350. However, given that the Matching System processes
messages serially,\52\ the Matching System would not consider releasing
Order B until after Order C had been processed at 10:00:00.000365, at
which point it would be handled as follows:
---------------------------------------------------------------------------
\52\ See id.
---------------------------------------------------------------------------
[cir] At 10:00:00.000365, the Matching System would compare the
releasable time of Order B to the initial receipt time of the message
at the top of the Inbound Queue: Order D. Since Order D was received
during the Fixed LTAD Period for Order B, Order D would be evaluated
before releasing Order B and
[[Page 65447]]
immediately processed without being diverted into LTAD as it adds
liquidity to the CHX book and is not a delayable message. However, due
to the system-processing delay, Order D would actually post to the CHX
book at 10:00:00.000415. The result is that the NBBO would become 10.01
x 10.02 and the CHX book would be as follows:
Fig 2c--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Order D: 1000 @10.01...................... Order C: 1000 @10.02.
------------------------------------------------------------------------
[cir] At 10:00:00.000415, the Matching System would then compare
the releasable time of Order B to the initial receipt time of the next
message at the top of the Inbound Queue: Cancel Order B. Since Cancel
Order B was received when Order B was in the LTAD queue, Cancel Order B
would be diverted into LTAD as it is a cancel message for an order that
has yet to be released from LTAD. However, due to the system-processing
delay, Cancel Order B would be diverted into LTAD at 10:00:00.000465
and releasable at 10:00:00.000675. The result is that the LTAD queue
would be as follows:
Fig 2d--LTAD Queue
------------------------------------------------------------------------
Releaseable time Message
------------------------------------------------------------------------
10:00:00.000350........................... Order B: Buy 1000 @10.01.
10:00:00.000675........................... Cancel Order B.
------------------------------------------------------------------------
[cir] At 10:00:00.000465, the Matching System would then compare
the releasable time of Order B to the initial receipt time of the next
message at the top of the Inbound Queue: Order E. However, given that
Order E was received after the Fixed LTAD Period for Order B had
expired, the Matching System would release Order B before evaluating
Order E. Due to the system-processing delay, Order B would actually
post to the CHX book at 10:00:00.000515. Also, given that Order B was
initially received before Order D, Order B would receive execution
priority over Order D, pursuant to Article 20, Rule 8(b)(1). The result
is that the CHX book would be as follows:
Fig 2e--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Order B: 1000 @10.01...................... Order C: 1000 @10.02.
Order D: 1000 @10.01...................... ............................
------------------------------------------------------------------------
Order E would then be evaluated at 10:00:00.000515, due to
the variable message queuing delay, and since it would execute against
Order B, it would be diverted into LTAD at 10:00:00.000565, due to the
system-processing delay, and releasable at 10:00:00.000705. The result
is that the LTAD queue would be as follows:
Fig 2f--LTAD Queue
------------------------------------------------------------------------
Releasable time Message
------------------------------------------------------------------------
10:00:00.000675........................... Cancel Order B.
10:00:00.000705........................... Order E: Sell 1000 @10.01.
------------------------------------------------------------------------
Cancel Order B would then be released from LTAD at
10:00:00.000675, as there are no messages received during its Fixed
LTAD Period in the Inbound Queue. Thus, Cancel Order B would be
processed and Order B would be cancelled at 10:00:00.000725, due to the
system-processing delay. The result is that the CHX Book and the LTAD
queue would be as follows:
Fig 2g--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Order D: 1000 @10.01...................... Order C: 1000 @10.02.
------------------------------------------------------------------------
Fig 2h--LTAD Queue
------------------------------------------------------------------------
Releasable time Message
------------------------------------------------------------------------
10:00:00.000705........................... Order E: Sell 1000 @10.01.
------------------------------------------------------------------------
Order E would then be released from LTAD at
10:00:00.000725, as the Matching System was processing Cancel Order B
when Order E became releasable at 10:00:00.000705. Order E would then
be processed and fully execute against Order D at $10.01/share at
10:00:00.000775, due to the system-processing delay. The result is that
the Inbound Queue and the LTAD queue would be empty and the CHX Book
would be as follows:
Fig 2h--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Empty..................................... Order C: 1000 @10.02.
------------------------------------------------------------------------
Example 3: Post Only and Routing--Immediate Feedback. Assume the
same as Example 2 and that the NBBO is 10.01 x 10.02 with only one
market (``Away Market A1'') displaying 1,000 shares at the
NBB (``Protected Bid A1''). Assume also that there are no
Protected Bids at $10.00. Assume then that the Matching System receives
the following new messages in security XYZ:
Fig 3a--Inbound Queue
------------------------------------------------------------------------
Initial receipt Message
------------------------------------------------------------------------
10:00:00.000800........................... Cancel Order C.
10:00:00.001000........................... Order F: Buy 1000 @10.00.
10:00:00.001010........................... Order G: Sell 2000 @9.99.
10:00:00.001020........................... Order H: Sell 2000 @9.99.
10:00:00.001030........................... Cancel Order F.
10:00:00.001040........................... Order I: Post Only Buy 1000
@10.00.
------------------------------------------------------------------------
Under this Example 3:
Cancel Order C would be evaluated at 10:00:00.000800 and
then immediately processed without being diverted into LTAD as it would
cancel a resting order and is not a delayable message. However, due to
the system-processing delay, Order C would actually be cancelled at
10:00:00.000850 resulting in the CHX Book becoming empty.
Order F would then be evaluated and processed at
10:00:00.001000 without being diverted into LTAD as it would provide
liquidity and is not a delayable message. However, due to the system-
processing delay, Order F would actually post to the CHX book at
10:00:00.001050. The result is that the CHX Book would be as follows:
Fig 3b--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Order F: 1000 @10.00...................... Empty.
------------------------------------------------------------------------
Order G would then be evaluated at 10:00:00.001050, due to
variable message queuing delay. Pursuant to the Exchange's routing
protocol, the Exchange would immediately route 1,000 shares of Order G
priced at 10.01/share to satisfy Protected Bid A1.\53\
Moreover, since the unrouted 1000 shares of Order G could execute
against Order F at 10.00, the unrouted 1000 shares of Order G would be
diverted into LTAD at 10:00:00.001100, due to system-processing delay,
and releasable at 10:00:00.001360. The result is that the LTAD queue
would be as follows:
---------------------------------------------------------------------------
\53\ The Exchange notes that the time it takes for the Exchange
to receive confirmation from the away market for a routed order is
much longer than the proposed 350 microsecond LTAD. Thus, it is
highly unlikely that the Exchange would receive an execution report
from the away market before a delayed unrouted portion is released
from LTAD. See supra notes 44 and 45.
[[Page 65448]]
Fig 3c--LTAD Queue
------------------------------------------------------------------------
Releasable time Message
------------------------------------------------------------------------
10:00:00.001360........................... Order G: Sell 1000 @9.99.
------------------------------------------------------------------------
Order H would then be evaluated at 10:00:00.001100, due to
variable message queuing delay. Given that Order H is virtually
identical to Order G and that the proposed Immediate Feedback is only
applied on an order-by-order basis, Order H would be handled exactly as
Order G. Specifically, the Exchange would immediately route 1000 shares
of Order H priced at 10.01/share to satisfy Protected Bid
A1. Moreover, since the unrouted 1000 shares of Order H
could execute against Order F at 10.00, the unrouted 1000 shares of
Order H would be diverted into LTAD at 10:00:00.001150, due to system-
processing delay, and releasable at 10:00:00.001370. The result is that
the LTAD queue would be as follows:
Fig 3d--LTAD Queue
------------------------------------------------------------------------
Releasable time Message
------------------------------------------------------------------------
10:00:00.001360........................... Order G: Sell 1000 @9.99.
10:00:00.001370........................... Order H: Sell 1000 @9.99.
------------------------------------------------------------------------
Cancel Order F would then be evaluated at 10:00:00.001150,
due to variable message queuing delay, but would be immediately
processed without being diverted into LTAD as it would cancel a resting
order and is not a delayable message. However, due to the system-
processing delay, Order F would actually be cancelled at
10:00:00.001200. The result is that the CHX book would become empty.
Order I would then be evaluated at 10:00:00.001200, due to
variable message queuing delay, but would be immediately processed
without being diverted into LTAD as it would provide liquidity and is
not a delayable message. However, due to the system-processing delay,
Order I would actually post to the CHX book at 10:00:00.001250. The
result is that the CHX book would be as follows:
Fig 3e--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Order I: Post Only 1000 @10.00............ Empty.
------------------------------------------------------------------------
Unrouted remainder of Order G would be released from LTAD
at 10:00:00.001360, as all messages received during the Fixed LTAD
Period for Order G have already been processed.\54\ Thus, Order G would
be processed and given the Immediate Feedback received from the routed
portion of Order G and the fact that the Immediate Feedback had not
expired, the unrouted remainder of Order G would fully execute against
Order I at 10.00/share \55\ at 10:00:00.001410, due to system-
processing delay.\56\ The result is that the CHX book would become
empty.
---------------------------------------------------------------------------
\54\ See id.
\55\ See CHX Article 20, Rule 8(d)(1).
\56\ The Exchange notes that Order I would receive the liquidity
provide credit and Order G would be charged the liquidity taking
fee, pursuant to Section E.1 of the Fee Schedule of the Exchange,
even though Order I was initially received after Order G.
---------------------------------------------------------------------------
Unrouted remainder of Order H would be released from LTAD
at 10:00:00.001410 as the Matching System was processing the unrouted
remainder of Order G when the unrouted remainder of Order H became
releasable at 10:00:00.001370. Thus, Order H would be processed and
given the Immediate Feedback received from the routed portion of Order
H and the fact that the Immediate Feedback had not expired, the
unrouted remainder of Order H would post to the CHX book at
10:00:00.001460, due to system-processing delay. The result is that the
CHX book would be as follows:
Fig 3f--CHX Book
------------------------------------------------------------------------
Buy Sell
------------------------------------------------------------------------
Empty..................................... Order H: 1000 at 9.99.
------------------------------------------------------------------------
Example 4: Routing--Expired Feedback. Assume the same as Example 3,
except that immediately prior to the unrouted portion of Order G being
released, the Exchange received an updated quote from Away Market
A1 displaying 1,000 shares at the $10.01.
Under this Example 4, the Immediate Feedback derived from the
immediately routed portion of Order G would expire and, upon release of
the unrouted delayed portion of Order G, the Matching System would
route the entire unrouted portion to satisfy the updated Protected Bid
displayed by Away Market A1.
Similarly, the Immediate Feedback derived from the immediately
routed portion of Order H would also expire and, upon release of the
unrouted delayed portion of Order H, the Matching System would route
the entire unrouted portion to satisfy the updated Protected Bid
displayed by Away Market A1.
Example 5: MTP. Assume the same as Example 3, except that Order G
and Order I originated from the same MTP Trading Group and Order G has
an MTP Action of ``N.''
Under this Example 5, pursuant to the current MTP rules, MTP would
be triggered and the unrouted remainder of Order G would be cancelled,
as the current ``N'' MTP Action requires the incoming order to be
cancelled. However, pursuant to the proposed amended MTP rules, Order I
would be cancelled, as the amended ``N'' MTP action requires the newer
order to be cancelled, absent a price sliding event.
Operative Date
In the event the proposed rule change is approved by the SEC, the
proposed rule change shall be operative pursuant to notice by the
Exchange to its Participants. Prior to the operative date, the Exchange
will ensure that policies and procedures are in place to allow Exchange
operations personnel to effectively monitor the operation of LTAD.
Appendix A: CHX ETF Analysis
The purpose of the CHX ETF Analysis is to demonstrate that latency
arbitrage activity \57\ in SPY at CHX (``SPY latency arbitrage
activity'') has (1) reduced volume and displayed liquidity in SPY at
CHX and (2) impaired liquidity provision in SPY marketwide. For the
purpose of this CHX ETF Analysis, the following terms shall have the
following meanings: \58\
---------------------------------------------------------------------------
\57\ See supra note 3.
\58\ Other capitalized terms utilized in the CHX ETF Analysis
shall have the meanings set forth under Appendix B.
---------------------------------------------------------------------------
After Period refers to February 2016 through July 2016.
Analysis Period refers to August 2015 through July 2016.
Before Period refers to August 2015 through December 2015.
Control Average refers to the arithmetic average of a
given metric for Control Securities.
Control Securities refers to DIA, IWM, and QQQ.\59\
---------------------------------------------------------------------------
\59\ Each of the Control Securities were selected for the
following similarities to SPY in that each is: (1) Highly correlated
in price movements with a well-known equity market index; (2) ETFs;
(3) traded in CHX's Chicago data center; (4) actively traded in the
NMS; and (5) Highly correlated with a futures contract traded
electronically on the Globex trading platform.
---------------------------------------------------------------------------
Entry Event refers to a trading day in January 2016 on
which latency arbitrage activity in SPY at CHX was first observed.
[[Page 65449]]
Entry Month refers to January 2016, the month in which
latency arbitrage activity in SPY at CHX was first observed.
Subject Securities refers to SPY and the Control
Securities.
Entry of SPY Latency Arbitrage Activity
During the After Period, the Exchange observed unusual messaging
patterns in SPY whereby executions of large inbound Immediate Or Cancel
(``IOC'') \60\ orders against resting orders in SPY were frequently
followed by the receipt of late cancel messages for the executed
resting orders very soon after the execution. This observation was
corroborated by feedback from liquidity providing Participants that
indicated that, unlike prior to the Entry Event, they were no longer
able to reliably cancel or cancel/adjust resting orders on the CHX book
in SPY in response to market changes after the Entry Event. The
Exchange believes that each instance of the unusual messaging pattern
is the end result of a race triggered by an away market event (e.g.,
change in market data from a futures market) where the liquidity taker
is able to take a resting order at a stale price before the liquidity
provider could adjust the resting order to accurately reflect the
market.\61\ As such, the SPY latency arbitrage activity has had the
following impact on volume and liquidity in SPY at CHX and away
exchanges:
---------------------------------------------------------------------------
\60\ See CHX Article 1, Rule 2(d)(4).
\61\ See supra note 10.
---------------------------------------------------------------------------
Analysis 1: SPY Latency Arbitrage Activity Reduced CHX Market Share in
SPY Relative to Total Volume in SPY and Disproportionately To Control
Securities
As shown under Figure 1, CHX Market Share in SPY as a percentage of
Total Volume dropped by 90.1% from 5.73% in the Entry Month to 0.57% in
July 2016, while CHX Market Share in the Control Average dropped by
45.20% from 5.54% in the Entry Month to 3.03% in July 2016.\62\ As
shown under Figure 2, changes in the average Total Volume during the
Analysis Period for the Subject Securities were highly correlated.
Thus, Figure 1 and Figure 2 show that despite the high correlation
between SPY and each of the Control Securities during the Analysis
Period, the CHX Market Share in SPY decreased disproportionately to
Total Volume, which the Exchange submits is attributed to the SPY
latency arbitrage activity.
---------------------------------------------------------------------------
\62\ See infra Appendix B Calculation Set 1a.
[GRAPHIC] [TIFF OMITTED] TN22SE16.001
Figure 1. This figure illustrates the decrease in CHX Market Share
as a percentage of Total Volume in the Subject Securities (Index:
January 2016 = 100).\63\
---------------------------------------------------------------------------
\63\ See infra Appendix B Calculation Sets 1a and 1b.
---------------------------------------------------------------------------
[[Page 65450]]
[GRAPHIC] [TIFF OMITTED] TN22SE16.002
Figure 2. This figure illustrates the correlation in the Total
Volume between SPY and the Control Average (Index: January 2016 = 100)
during the Analysis Period.\64\ \65\
---------------------------------------------------------------------------
\64\ The correlation coefficients ([rho]) over the twelve-month
period were: [rho](SPY, DIA) = 0.9118, [rho](SPY, IWM) = 0.8996,
[rho](SPY, QQQ) = 0.9392, [rho](SPY, Average) = 0.9493.
\65\ See infra Appendix B Calculation Sets 2a and 2b.
---------------------------------------------------------------------------
Analysis 2: SPY Latency Arbitrage Activity Resulted in Less
Aggressively Priced and Smaller Orders in SPY at CHX
While the Exchange did not observe any discernable change on the
NBBO spread in SPY during the After Period, the Exchange did observe a
negative impact on the frequency at which CHX was at the NBBO in SPY
and the frequency at which CHX displayed the largest quote at the NBBO
in SPY during the After Period, while Control Securities experienced
either smaller declines or no declines at all.\66\
---------------------------------------------------------------------------
\66\ See infra Appendix B Calculation Sets 6 and 7.
---------------------------------------------------------------------------
Specifically, the % of Time CHX Was At The NBB decreased from 23.8%
in the Entry Month to 8.2% in July 2016; \67\ the % of Time CHX Was At
The NBO decreased from 23.3% in the Entry Month to 5.8% in July 2016;
\68\ and the % of Time CHX Was At The NBB and that CHX Was At The NBO
decreased from 3.3% in the Entry Month to 0% in July 2016.\69\
---------------------------------------------------------------------------
\67\ See infra Appendix B Calculation Set 6a.
\68\ See infra Appendix B Calculation Set 6b.
\69\ See infra Appendix B Calculation Set 6c.
---------------------------------------------------------------------------
Moreover, the % of Time CHX Was At The NBB And Was The Largest Bid
At That Price decreased from 20% in the Entry Month to 2.3% in July
2016; \70\ the % of Time CHX Was At The NBO And Was The Largest Offer
At That Price decreased from 20.7% in the Entry Month to 1.1% in July
2016; \71\ and the % of Time CHX Was At The NBB And Was The Largest Bid
At That Price and that CHX Was At The NBO And Was The Largest Offer At
That Price decreased from 1.9% to 0%.\72\
---------------------------------------------------------------------------
\70\ See infra Appendix B Calculation Set 7a.
\71\ See infra Appendix B Calculation Set 7b.
\72\ See infra Appendix B Calculation Set 7c.
---------------------------------------------------------------------------
These calculation sets clearly show that SPY latency arbitrage
activity resulted in less aggressively priced CHX displayed liquidity
in SPY and smaller CHX displayed size at the NBBO, during the After
Period. SPY latency arbitrage also negatively impacted the percentage
of the time that CHX was at the NBBO and the percentage of the time CHX
displayed the largest quote at the NBBO.
Analysis 3: Latency Arbitrage Activity at CHX Reduced CHX Size at The
NBBO in SPY Relative to the Control Securities and NMS Size at The NBBO
As shown under Figure 3, during the Before Period, the Time-
weighted Average CHX Size at The NBBO for SPY tended to follow changes
to the Control Average, whereas from the Entry Month through July 2016,
the Time-weighted Average CHX Size At The NBBO for SPY decreased by
82.16% and the Time-weighted Average CHX Size At The NBBO for the
Control Average increased by 64.38%.\73\ As shown under Figure 4,
during the Before Period, the monthly changes in the Time-weighted
Average CHX Size At The NBBO tended to follow similar changes to the
Time-weighted Average NMS Size At The NBBO. However, during the After
Period, the monthly changes in the Time-weighted Average CHX Size At
The NBBO in SPY did not follow changes to the Time-weighted Average NMS
Size At The NBBO in SPY. Moreover, during the After Period, CHX went
from having a Two-Sided Market in SPY 100% of regular trading hours in
the Entry Month to 74% of regular trading hours in July 2016.\74\
---------------------------------------------------------------------------
\73\ See infra Appendix B Calculation Sets 3a and 3b.
\74\ See infra Appendix B Calculation Set 5.
---------------------------------------------------------------------------
Thus, Figure 3 and Figure 4 show that SPY latency arbitrage
negatively impacted liquidity in SPY marketwide. Moreover, the data
shows that the change in the risk/reward of providing liquidity in SPY
at CHX which resulted from the introduction of the SPY latency
arbitrage activity resulted in a significant reduction of liquidity in
SPY provided by CHX, even during a period when significant incremental
liquidity was being added in the Control Securities.
[[Page 65451]]
[GRAPHIC] [TIFF OMITTED] TN22SE16.003
Figure 3. This figure illustrates the Time-weighted Average CHX
Size At The NBBO in the Subject Securities (Indexed: January 2016 =
100) during the Analysis Period.\75\
---------------------------------------------------------------------------
\75\ See infra Appendix B Calculation Sets 3a and 3b.
[GRAPHIC] [TIFF OMITTED] TN22SE16.004
Figure 4. This figure illustrates the Time-weighted Average CHX
Size At The NBBO in SPY versus Time-weighted Average NMS Size At The
NBBO in SPY (Indexed: January 2016 = 100) during the Analysis
Period.\76\
---------------------------------------------------------------------------
\76\ See infra Appendix B Calculation Sets 3b and 4b.
---------------------------------------------------------------------------
Analysis 4: SPY Latency Arbitrage Activity Reduced Displayed Liquidity
in SPY Marketwide
Although the Time-weighted Average NMS Size At The NBBO in SPY
increased by 22.83% during the After Period, the increase in SPY did
not follow much greater increases in the Time-weighted Average NBBO
Size in the Control Group, which increased by 128.82% during the After
Period.\77\ Moreover, during the After Period, the Time-weighted
Average CHX Size At The NBBO for SPY decreased by 90.61% \78\ and, as a
% of total NMS Size At The NBBO in SPY, from 44.36% to
[[Page 65452]]
3.39%.\79\ These calculations suggest that the SPY latency arbitrage
activity materially impacted displayed liquidity in SPY marketwide. The
dramatic decrease in displayed liquidity in SPY at CHX during the After
Period explains why the increase in Time-weighted Average NBBO Size in
SPY lagged behind the increase in Time-weighted Average NBBO Size in
the Control Securities. Had CHX Size At The NBBO remained at least
constant during the After Period, NBBO Size in SPY would have been at
least 32.7% higher in July 2016, as shown below: \80\
---------------------------------------------------------------------------
\77\ See infra Appendix B Calculation Set 4a.
\78\ See infra Appendix B Calculation Set 3a.
\79\ See infra Appendix B Calculations Sets 3a and 4a.
\80\ See infra Appendix B Calculation Set 4a.
----------------------------------------------------------------------------------------------------------------
NMS size at NBBO Change attribution
-------------------------------------------------------------------------------
Jan-16 Jul-16 Change CHX Others
----------------------------------------------------------------------------------------------------------------
SPY............................. 9,513 11,686 2,172 -3,824 5,996
DIA............................. 2,569 4,711 2,142 1,227 915
IWM............................. 5,222 10,026 4,804 536 4,268
QQQ............................. 14,100 35,354 21,253 3,900 17,353
Control Average................. 7,297 16,697 9,400 1,888 7,512
----------------------------------------------------------------------------------------------------------------
Conclusion
Based on its observations of unusual messaging patterns in SPY,
feedback from Participants and the analysis summarized above, the
Exchange believes that the unusual messaging activity in SPY that was
first observed in the Entry Month is attributed to SPY latency
arbitrage activity. The market data shows that in response to the SPY
latency arbitrage activity, CHX liquidity providers displayed smaller
orders in SPY at less aggressive prices during the After Period
relative to the Before Period and Entry Month. Moreover, in light of
CHX's significant contribution to overall volume and liquidity in SPY
during the Before Period and the Entry Month, diminished displayed
liquidity at CHX has materially impaired displayed liquidity in SPY
marketwide.
Appendix B: Calculation Sets
The calculations sets below were prepared with microsecond-level
trade and quote record. Trade records include the date, microsecond-
level timestamp, exchange, security symbol, price, and quantity of all
trades reported to the consolidated tape. Quote records include the
date, microsecond-level timestamp, exchange, security symbol, bid
price, bid quantity, ask price, and ask quantity of all quotes reported
to the consolidated tape. Only protected quotations are reported to the
consolidated tape.
The Analysis Period for the calculations begins on August 1, 2015
and ends on July 31, 2016. Symbols SPY and three other Control
Securities (i.e., DIA, IWM, and QQQ) were considered. Only trades and
quotes that occurred on the national securities exchanges during the
regular trading hours \81\ were considered. Certain types of non-
standard trades were excluded.\82\ Quotes with negative prices or
quantities were excluded. Unless otherwise indicated, lengths of time
when the market was locked or crossed were not considered.
---------------------------------------------------------------------------
\81\ See 17 CFR 242.600(b)(64).
\82\ Non-standard trades include derivatively priced trades,
qualified contingent trades, opening trades, closing trades, and
after hours trades.
---------------------------------------------------------------------------
In the calculations below:
Total Volume refers to the number of shares of the
indicated symbol traded on the national securities exchanges on a given
day, excluding certain types of non-standard trades. CHX Volume refers
to the number of shares of the indicated symbol traded on CHX on a
given day, excluding certain types of non-standard trades.
CHX Market Share was calculated as CHX Volume divided by
Total Volume on a given day, CHX Market Share = CHX Volume / Total
Volume.
CHX Had A Two-Sided Market refers to an indicator variable
defined as true at any microsecond when there was at least one bid and
at least one offer among all outstanding orders on CHX, and false
otherwise. CHX Had A One-Sided Market refers to an indicator variable
defined as true at any microsecond when there was at least one bid but
no offers among all outstanding orders on CHX or when there was at
least one offer but no bids among all outstanding orders on CHX, and
false otherwise. CHX Had No Market refers to an indicator variable
defined as true at any microsecond when there were no outstanding
orders on CHX, and false otherwise.
A bid was At The NBB at any microsecond when its price was
equal to the National Best Bid. An offer was At The NBO at any
microsecond when its price was equal to the National Best Offer.
At any microsecond, the NMS Size At The National Best Bid
(``NMS Size At The NBB'') refers to the quantity of shares in
prevailing bids on the national securities exchanges priced at the
National Best Bid and the NMS Size At The National Best Offer (``NMS
Size At The NBO'') refers to the quantity of shares in prevailing
offers on the national securities exchanges priced at the National Best
Offer. NMS Size At The NBBO was calculated as the average of the
National Best Bid Size and the National Best Offer Size at each
microsecond, NMS Size At The NBBO = (NMS Size At The NBB + NMS Size At
The NBO) / 2.
CHX Was At The NBB refers to an indicator variable defined
as true at any microsecond when the CHX Best Bid was at the National
Best Bid, and false otherwise. CHX Was At The NBO refers to an
indicator variable defined as true at any microsecond when the CHX Best
Offer was at the National Best Offer, and false otherwise.
At any microsecond, the CHX Size At The NBB (``CHX Size At
The NBB'') refers to the CHX Best Bid Size if CHX was at the NBB and
zero if CHX was not at the NBB. At any microsecond, the CHX Size At The
NBO (``CHX Size At The NBO'') refers to the CHX Best Offer Size if CHX
was at the NBO and zero if CHX was not at the NBO. CHX Size At The NBBO
was calculated as the average of the CHX Size At The NBB and CHX Size
At The NBO at each microsecond, CHX Size At The NBBO = (CHX Size At The
NBB + CHX Size At The NBO) / 2.
CHX Was At The NBB And Was The Largest Bid At That Price
refers to an indicator variable defined as true at any microsecond when
CHX was at the National Best Bid and the CHX Best Bid Size was greater
than or equal to the largest quantity of shares in prevailing bids on
any one national securities exchange other than CHX, and false
otherwise. CHX Was At The NBO And Was The Largest Offer At That Price
refers to an indicator variable defined as true at any microsecond when
CHX was at the National Best Offer and the CHX Best Offer Size was
greater than or equal to the largest quantity of shares in prevailing
offers on any one national securities exchange other than CHX, and
false otherwise.
[[Page 65453]]
For the calculations in the table below:
Monthly average values are shown. Monthly
average values were calculated as the average of daily values for each
day in a month. Daily values were calculated as time-weighted averages
or as percentages of time in the trading day, as indicated in the
table. Time-weighted average values were calculated as daily average of
the specified quantity, market share, or spread value weighted by time
(in microseconds). % of time values were calculated as the length of
time (in microseconds) for which the specified indicator variable was
true divided by the length of time in that trading day, excluding
lengths of time during which the market was locked or crossed or
otherwise could not be calculated (e.g., at the start of the trading
day).
----------------------------------------------------------------------------------------------------------------
Symbol
----------------------------------------------------------------
SPY DIA IWM QQQ Control
No. Calculation Month ---------------------------------------------------- average
------------
[1] [2] [3] [4] ([2]:[4])
----------------------------------------------------------------------------------------------------------------
[1a]...... CHX Market Share Aug 2015......... 4.32% 3.07% 5.51% 3.40% 3.99%
(% of Total
Volume).
Sep 2015......... 6.07% 2.61% 3.82% 3.46% 3.30%
Oct 2015......... 4.08% 5.95% 2.58% 4.42% 4.32%
Nov 2015......... 4.49% 8.58% 3.14% 5.13% 5.62%
Dec 2015......... 4.85% 4.89% 2.53% 4.49% 3.97%
Jan 2016......... 5.73% 9.13% 3.14% 4.35% 5.54%
Feb 2016......... 4.78% 9.13% 3.32% 4.41% 5.62%
Mar 2016......... 2.80% 7.54% 2.38% 3.57% 4.50%
Apr 2016......... 2.28% 4.41% 2.01% 2.69% 3.04%
May 2016......... 1.10% 3.53% 2.21% 1.93% 2.55%
Jun 2016......... 0.90% 5.17% 1.74% 3.00% 3.30%
Jul 2016......... 0.57% 6.11% 1.22% 1.77% 3.03%
[1b]...... CHX Market Share Aug 2015......... 75 34 176 78 72
(% of Total Sep 2015......... 106 29 122 80 60
Volume).
Index: January
2016 = 100.
Oct 2015......... 71 65 82 102 78
Nov 2015......... 78 94 100 118 101
Dec 2015......... 85 54 81 103 72
Jan 2016......... 100 100 100 100 100
Feb 2016......... 83 100 106 102 102
Mar 2016......... 49 83 76 82 81
Apr 2016......... 40 48 64 62 55
May 2016......... 19 39 70 44 46
Jun 2016......... 16 57 55 69 60
Jul 2016......... 10 67 39 41 55
[2a]...... Average Total Aug 2015......... 130,150,083 6,153,725 26,846,599 33,963,873 23,568,046
Volume.
Sep 2015......... 94,627,144 6,552,649 21,381,524 28,452,481 19,947,099
Oct 2015......... 75,881,581 4,461,519 22,420,310 22,701,556 14,268,977
Nov 2015......... 63,307,314 3,673,677 16,624,141 17,531,483 10,308,999
Dec 2015......... 87,011,822 4,969,853 23,287,782 24,474,150 16,211,695
Jan 2016......... 127,469,871 8,301,912 35,204,822 39,029,308 21,425,674
Feb 2016......... 97,911,733 6,121,299 27,668,000 35,547,824 18,060,375
Mar 2016......... 63,333,000 2,521,807 20,709,893 17,600,599 9,724,974
Apr 2016......... 53,023,531 2,337,084 15,556,074 14,984,599 8,991,216
May 2016......... 51,578,634 2,016,095 17,899,288 14,856,962 9,822,504
Jun 2016......... 78,385,026 2,740,421 20,938,721 16,963,513 10,240,678
Jul 2016......... 49,783,615 2,130,330 14,122,275 11,973,239 5,657,111
[2b]...... Average Total Aug 2015......... 102 74 76 87 110
Volume. Sep 2015......... 74 79 61 73 93
Index: Jan 2016
= 100.
Oct 2015......... 60 54 64 58 67
Nov 2015......... 50 44 47 45 48
Dec 2015......... 68 60 66 63 76
Jan 2016......... 100 100 100 100 100
Feb 2016......... 77 74 79 91 84
Mar 2016......... 50 30 59 45 45
Apr 2016......... 42 28 44 38 42
May 2016......... 40 24 51 38 46
Jun 2016......... 61 33 59 43 48
Jul 2016......... 39 26 40 31 26
[3a]...... Time-weighted Aug 2015......... 7,740.13 753.47 2,294.04 3,666.82 2,238.11
Average CHX Sep 2015......... 6,217.48 682.18 2,157.29 4,177.88 2,339.12
Size At The
NBBO.
Oct 2015......... 7,816.38 1,308.53 2,052.68 6,130.87 3,164.03
Nov 2015......... 8,983.84 2,439.37 2,158.33 7,182.16 3,926.62
Dec 2015......... 5,776.73 1,152.21 1,517.59 4,347.08 2,338.96
Jan 2016......... 4,220.05 1,830.97 1,726.35 4,341.83 2,633.05
Feb 2016......... 2,642.32 1,829.95 2,004.50 4,523.73 2,786.06
Mar 2016......... 1,611.90 2,347.82 2,077.08 5,987.78 3,470.89
Apr 2016......... 1,415.95 1,481.35 2,314.10 6,196.84 3,330.76
May 2016......... 485.23 1,469.69 2,374.66 7,423.33 3,755.89
Jun 2016......... 565.73 1,772.03 2,188.41 7,994.73 3,985.06
Jul 2016......... 396.37 3,057.61 2,262.70 8,241.77 4,520.69
[[Page 65454]]
[3b]...... Time-weighted Aug 2015......... 183 41 133 84 85
Average CHX Sep 2015......... 147 37 125 96 89
Size At The Oct 2015......... 185 71 119 141 120
NBBO.
Index: Jan 2016
= 100.
Nov 2015......... 213 133 125 165 149
Dec 2015......... 137 63 88 100 89
Jan 2016......... 100 100 100 100 100
Feb 2016......... 63 100 116 104 106
Mar 2016......... 38 128 120 138 132
Apr 2016......... 34 81 134 143 126
May 2016......... 11 80 138 171 143
Jun 2016......... 13 97 127 184 151
Jul 2016......... 9 167 131 190 172
[4a]...... Time-weighted Aug 2015......... 19,257.66 2,609.35 6,511.42 18,471.79 9,197.52
Average NMS Sep 2015......... 11,919.38 1,679.93 6,540.46 14,223.92 7,481.44
Size At The
NBBO.
Oct 2015......... 18,309.27 2,468.56 6,972.46 19,848.75 9,763.26
Nov 2015......... 19,257.58 3,930.75 6,963.92 23,442.48 11,445.72
Dec 2015......... 13,230.66 2,204.20 5,812.28 17,106.74 8,374.40
Jan 2016......... 9,513.33 2,569.26 5,221.94 14,100.46 7,297.22
Feb 2016......... 7,417.60 2,489.46 6,340.40 13,869.32 7,566.40
Mar 2016......... 8,638.39 3,703.26 8,521.28 20,316.43 10,846.99
Apr 2016......... 9,876.59 3,070.53 9,422.71 23,246.57 11,913.27
May 2016......... 9,398.26 3,144.93 10,295.88 28,354.88 13,931.90
Jun 2016......... 9,313.10 3,107.54 9,597.43 28,288.57 13,664.51
Jul 2016......... 11,685.53 4,711.37 10,026.35 35,353.64 16,697.12
[4b]...... Time-weighted Aug 2015......... 202 102 125 131 126
Average NMS Sep 2015......... 125 65 125 101 103
Size At The Oct 2015......... 192 96 134 141 134
NBBO.
Index: Jan 2016
= 100.
Nov 2015......... 202 153 133 166 157
Dec 2015......... 139 86 111 121 115
Jan 2016......... 100 100 100 100 100
Feb 2016......... 78 97 121 98 104
Mar 2016......... 91 144 163 144 149
Apr 2016......... 104 120 180 165 163
May 2016......... 99 122 197 201 191
Jun 2016......... 98 121 184 201 187
Jul 2016......... 123 183 192 251 229
[5a]...... % of Time CHX Aug 2015......... 99.8% 99.6% 99.7% 99.6% 99.7%
Had A Two-Sided
Market.
Sep 2015......... 99.9% 99.9% 99.9% 99.9% 99.9%
Oct 2015......... 100.0% 99.9% 99.9% 100.0% 99.9%
Nov 2015......... 99.9% 99.9% 99.5% 99.8% 99.7%
Dec 2015......... 98.6% 98.3% 98.6% 98.6% 98.5%
Jan 2016......... 100.0% 99.9% 99.9% 100.0% 99.9%
Feb 2016......... 99.9% 100.0% 100.0% 100.0% 100.0%
Mar 2016......... 99.8% 100.0% 100.0% 100.0% 100.0%
Apr 2016......... 99.3% 99.9% 100.0% 99.8% 99.9%
May 2016......... 85.2% 99.9% 100.0% 100.0% 100.0%
Jun 2016......... 73.2% 99.9% 100.0% 100.0% 100.0%
Jul 2016......... 74.0% 99.9% 100.0% 100.0% 100.0%
[5b]...... % of Time CHX Aug 2015......... 0.1% 0.1% 0.0% 0.2% 0.1%
Had A One-Sided
Market.
Sep 2015......... 0.0% 0.0% 0.0% 0.0% 0.0%
Oct 2015......... 0.0% 0.0% 0.0% 0.0% 0.0%
Nov 2015......... 0.0% 0.0% 0.0% 0.2% 0.1%
Dec 2015......... 0.0% 0.3% 0.0% 0.0% 0.1%
Jan 2016......... 0.0% 0.1% 0.0% 0.0% 0.0%
Feb 2016......... 0.0% 0.0% 0.0% 0.0% 0.0%
Mar 2016......... 0.2% 0.0% 0.0% 0.0% 0.0%
Apr 2016......... 0.2% 0.0% 0.0% 0.0% 0.0%
May 2016......... 3.0% 0.0% 0.0% 0.0% 0.0%
Jun 2016......... 6.1% 0.0% 0.0% 0.0% 0.0%
Jul 2016......... 1.8% 0.0% 0.0% 0.0% 0.0%
[5c]...... % of Time CHX Aug 2015......... 0.1% 0.3% 0.3% 0.1% 0.2%
Had No Market.
Sep 2015......... 0.0% 0.1% 0.1% 0.0% 0.1%
Oct 2015......... 0.0% 0.1% 0.1% 0.0% 0.1%
Nov 2015......... 0.1% 0.1% 0.4% 0.0% 0.2%
Dec 2015......... 1.4% 1.4% 1.4% 1.4% 1.4%
Jan 2016......... 0.0% 0.0% 0.0% 0.0% 0.0%
Feb 2016......... 0.1% 0.0% 0.0% 0.0% 0.0%
Mar 2016......... 0.0% 0.0% 0.0% 0.0% 0.0%
Apr 2016......... 0.5% 0.1% 0.0% 0.2% 0.1%
May 2016......... 11.8% 0.1% 0.0% 0.0% 0.0%
[[Page 65455]]
Jun 2016......... 20.7% 0.1% 0.0% 0.0% 0.0%
Jul 2016......... 24.2% 0.0% 0.0% 0.0% 0.0%
[6a]...... % of Time CHX Aug 2015......... 16.5% 32.7% 46.9% 58.0% 45.9%
Was At The NBB.
Sep 2015......... 24.0% 36.4% 44.7% 67.6% 49.6%
Oct 2015......... 30.8% 45.8% 44.3% 74.9% 55.0%
Nov 2015......... 24.5% 50.3% 54.0% 79.6% 61.3%
Dec 2015......... 29.2% 34.1% 38.3% 71.3% 47.9%
Jan 2016......... 23.8% 46.0% 40.2% 70.4% 52.2%
Feb 2016......... 15.5% 53.9% 33.7% 65.5% 51.0%
Mar 2016......... 18.5% 58.4% 35.6% 66.8% 53.6%
Apr 2016......... 18.7% 46.8% 35.9% 60.5% 47.7%
May 2016......... 7.0% 44.8% 53.5% 68.5% 55.6%
Jun 2016......... 5.4% 47.1% 44.2% 72.8% 54.7%
Jul 2016......... 8.2% 45.9% 40.8% 74.1% 53.6%
[6b]...... % of Time CHX Aug 2015......... 27.9% 39.8% 57.0% 65.6% 54.1%
Was At The NBO.
Sep 2015......... 29.7% 36.0% 41.8% 66.7% 48.2%
Oct 2015......... 20.9% 41.4% 42.7% 74.0% 52.7%
Nov 2015......... 28.7% 39.3% 52.9% 78.2% 56.8%
Dec 2015......... 27.1% 35.5% 42.4% 70.0% 49.3%
Jan 2016......... 23.3% 52.3% 48.8% 70.4% 57.2%
Feb 2016......... 23.2% 55.5% 46.3% 69.1% 57.0%
Mar 2016......... 19.0% 58.5% 44.4% 70.0% 57.7%
Apr 2016......... 14.0% 44.0% 36.4% 65.8% 48.7%
May 2016......... 12.4% 40.4% 49.3% 64.2% 51.3%
Jun 2016......... 11.0% 47.3% 48.4% 74.6% 56.8%
Jul 2016......... 5.8% 46.0% 34.0% 69.4% 49.8%
[6c]...... % of Time CHX Aug 2015......... 1.0% 8.2% 19.7% 32.5% 20.2%
Was At The NBB Sep 2015......... 2.0% 10.0% 9.2% 37.1% 18.8%
and that CHX
Was At The NBO.
Oct 2015......... 3.0% 14.4% 10.2% 49.8% 24.8%
Nov 2015......... 6.0% 14.2% 17.9% 58.1% 30.1%
Dec 2015......... 4.4% 9.3% 12.5% 44.8% 22.2%
Jan 2016......... 3.3% 19.2% 7.8% 41.8% 22.9%
Feb 2016......... 1.0% 24.5% 4.8% 35.4% 21.5%
Mar 2016......... 0.5% 29.6% 4.6% 38.0% 24.1%
Apr 2016......... 0.2% 15.7% 2.2% 29.9% 15.9%
May 2016......... 0.0% 13.5% 17.5% 34.6% 21.9%
Jun 2016......... 0.0% 17.0% 12.2% 48.5% 25.9%
Jul 2016......... 0.0% 12.6% 4.0% 44.1% 20.3%
[7a]...... % of Time CHX Aug 2015......... 13.6% 26.2% 37.1% 26.6% 29.9%
Was At The NBB Sep 2015......... 21.5% 34.0% 40.0% 47.6% 40.6%
And Was The
Largest Bid At
That Price.
Oct 2015......... 24.9% 43.8% 36.2% 57.4% 45.8%
Nov 2015......... 18.8% 47.9% 39.4% 55.9% 47.7%
Dec 2015......... 25.1% 31.7% 27.7% 39.1% 32.8%
Jan 2016......... 20.0% 43.6% 32.0% 48.1% 41.2%
Feb 2016......... 11.2% 52.7% 28.5% 45.5% 42.2%
Mar 2016......... 11.9% 55.7% 28.3% 44.8% 42.9%
Apr 2016......... 13.0% 42.2% 31.6% 43.6% 39.1%
May 2016......... 1.7% 39.8% 37.9% 50.2% 42.6%
Jun 2016......... 2.0% 43.7% 32.2% 48.3% 41.4%
Jul 2016......... 2.3% 43.2% 31.7% 48.0% 41.0%
[7b]...... % of Time CHX Aug 2015......... 24.3% 34.4% 51.2% 39.8% 41.8%
Was At The NBO Sep 2015......... 27.0% 33.8% 37.8% 46.7% 39.4%
And Was The
Largest Offer
At That Price.
Oct 2015......... 16.0% 38.1% 31.3% 44.0% 37.8%
Nov 2015......... 22.6% 36.8% 35.1% 53.4% 41.8%
Dec 2015......... 23.2% 32.7% 30.6% 36.8% 33.4%
Jan 2016......... 20.7% 51.1% 41.3% 50.7% 47.7%
Feb 2016......... 18.5% 54.7% 40.8% 49.4% 48.3%
Mar 2016......... 12.9% 55.2% 35.3% 51.2% 47.2%
Apr 2016......... 8.1% 38.6% 30.8% 45.9% 38.4%
May 2016......... 3.8% 36.7% 29.8% 45.2% 37.2%
Jun 2016......... 4.6% 44.6% 31.4% 51.8% 42.6%
Jul 2016......... 1.1% 42.5% 27.0% 31.0% 33.5%
[7c]...... % of Time CHX Aug 2015......... 0.2% 5.3% 12.8% 7.1% 8.4%
Was At The NBB Sep 2015......... 1.1% 8.5% 7.3% 16.7% 10.9%
And Was The Oct 2015......... 0.9% 12.3% 5.3% 17.7% 11.8%
Largest Bid At Nov 2015......... 2.3% 12.6% 7.0% 23.0% 14.2%
That Price and
that CHX Was At
The NBO And Was
The Largest
Offer At That
Price.
Dec 2015......... 2.9% 8.1% 6.4% 13.7% 9.4%
Jan 2016......... 1.9% 17.3% 4.3% 18.5% 13.4%
Feb 2016......... 0.3% 23.3% 2.8% 13.9% 13.3%
Mar 2016......... 0.1% 26.0% 2.6% 14.0% 14.2%
[[Page 65456]]
Apr 2016......... 0.0% 10.9% 1.5% 14.0% 8.8%
May 2016......... 0.0% 10.4% 8.0% 15.6% 11.3%
Jun 2016......... 0.0% 14.3% 4.8% 18.6% 12.5%
Jul 2016......... 0.0% 10.7% 2.8% 10.8% 8.1%
----------------------------------------------------------------------------------------------------------------
Appendix C: Impact of LTAD on Liquidity Takers
The purpose of this analysis is to show that implementation of LTAD
would not materially impact the ability of a random market participant
not engaged in a latency arbitrage strategy to take displayed liquidity
at CHX. This analysis assumes that LTAD would not materially change
order sending behavior of Participants.
For the period of May 2016 through July 2016,\83\ the Exchange
observed the following with regards to SPY:
---------------------------------------------------------------------------
\83\ For the months prior to May 2016 during the Analysis
Period, the Exchange did not maintain TLTC data. A limitation of
this data is that CHX Market Share and displayed liquidity in SPY
and, by extension, order sending activity had all diminished
considerably by May 2016. See supra Appendix B Calculation Set 1.
---------------------------------------------------------------------------
There were a total of 18,316 orders at least partially
executed.
During the same period, the Exchange received 1,278 cancel
messages to cancel resting orders after the resting order had been
fully executed (``too-late-to-cancel'' or ``TLTC'').
Of the 1,278 TLTCs, 412 TLTCs (32.24%) were received
sooner than or exactly 350 microseconds after the execution
(``TLTC<= 350''), whereas 866 (67.76%) were received later
than 350 microseconds after the execution (``TLTC> 350'').
Of the 412 TLTC<= 350, 392 (95.15%) executions
were attributed to SPY latency arbitrage activity while the remaining
20 (4.85%) executions were not.
Of the 866 TLTC> 350, 780 (90.07%) executions
were attributed to SPY latency arbitrage activity while the remaining
86 (9.93%) executions were not.\84\
---------------------------------------------------------------------------
\84\ See supra note 4.
---------------------------------------------------------------------------
Thus, if LTAD had been in effect for the period of May 2016 through
July 2016, LTAD (1) would have prevented up to 412 orders, virtually
all of which the Exchange believes were submitted as part of SPY
latency arbitrage activity, from being executed during the 350
microsecond Fixed LTAD Period and (2) would have had a negative impact
on only 20 liquidity taking orders not attributed to SPY latency
arbitrage activity. These 20 orders comprised 0.11% of the 18,316
orders executed during the period. That is, during the measurement
period of 63 trading days, LTAD would have had an adverse effect on
approximately one order every three trading days. Thus, LTAD can make a
significant contribution to leveling the playing field between
liquidity providers and latency arbitrageurs with minimal adverse
effect on other liquidity taking orders.
2. Statutory Basis
The Exchange believes that the proposed rule change is consistent
with Section 6(b) of the Act in general,\85\ and furthers the
objectives of Section 6(b)(5) in particular,\86\ in that it is designed
to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in facilitating
transactions in securities, to remove impediments and perfect the
mechanisms of a free and open market, and, in general, to protect
investors and the public interest; and is not designed to permit unfair
discrimination between customers, issuers, brokers, or dealers.
---------------------------------------------------------------------------
\85\ 15 U.S.C. 78f(b).
\86\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
Specifically, the Exchange believes that the proposed rule change
would remove impediments and perfect the mechanisms of a free and open
market and, in general, protect investors and the public interest by
enhancing displayed liquidity and price discovery for NMS securities by
minimizing the effectiveness of latency arbitrage strategies that
diminish quality and quantity of liquidity. As shown under the CHX ETF
Analysis, latency arbitrage lessens competition among orders by
dissuading liquidity providers from displaying large and aggressively
priced orders, which in turn impairs market efficiency.\87\ The
Commission has recognized the crucial role that displayed limit orders
play in the price discovery process.\88\ Thus, the Exchange believes
that optimizing liquidity provision on the Exchange will enhance price
discovery for NMS securities and, thereby, enhance market efficiency.
To this end, LTAD is designed to promote displayed liquidity on the
Exchange by giving liquidity providers a small amount of additional
time to cancel or adjust orders on the CHX book to comport to the most
recent market data before latency arbitrageurs could take such orders
at potentially ``stale'' prices. LTAD is designed to achieve these
goals without adversely affecting the ability of virtually all market
participants, other than latency arbitrageurs, to access liquidity at
CHX.\89\ Thus, the Exchange believes that LTAD will encourage liquidity
providers to resume posting large aggressively priced orders on the CHX
book, which was their practice prior to the beginning of the SPY
latency arbitrage activity in January 2016, which will enhance
liquidity and optimize price discovery in furtherance of the objectives
of Act and in a manner consistent with Regulation NMS, as described
below.
---------------------------------------------------------------------------
\87\ See Exchange Act Release No. 51808 (June 9, 2005), 70 FR
37496 at 37499 (June 29, 2005) (``Regulation NMS Adopting
Release''), which provides, in pertinent part: ``To the extent that
competition among orders is lessened, the quality of price discovery
for all sizes of orders can be compromised. Impaired price discovery
could cause market prices to deviate from fundamental values, reduce
market depth and liquidity, and create excessive short-term
volatility that is harmful to long-term investors and listed
companies. More broadly, when market prices do not reflect
fundamental values, resources will be misallocated within the
economy and economic efficiency--as well as market efficiency--will
be impaired.''
\88\ See Regulation NMS Adopting Release, id, at 37526.
\89\ See supra note 19; see also supra Appendix C.
---------------------------------------------------------------------------
The Exchange also believes that the proposed amendments to the MTP
order modifier would remove impediments and perfect the mechanisms of a
free and open market and, in general, protect investors and the public
interest, in that they are designed to avoid certain unintended
consequences of LTAD on the MTP functionality. Specifically, since an
order would be assigned a sequence number prior to being evaluated
pursuant to LTAD,\90\ LTAD may result in a newer undelayed order being
posted to the CHX book before an older delayed order, which would not
otherwise occur today. Under this
[[Page 65457]]
scenario and assuming that the contra-side orders trigger MTP and the
incoming order is marked ``N,'' the current MTP rules would require the
incoming older order to be cancelled, whereas the amended MTP handling
would require the resting newer order to be cancelled subject to the
exception for CHX Only orders described under amended Article 1, Rule
2(b)(3)(F)(iii)(a) and (b). Thus, the Exchange believes that the
amended MTP functionality better contemplates LTAD and preserves
expected results.
---------------------------------------------------------------------------
\90\ See supra note 7.
---------------------------------------------------------------------------
Moreover, the Exchange submits that the proposed rules for LTAD are
not designed to permit unfair discrimination, and would not impose any
unnecessary or inappropriate burden on competition. Rather, by
neutralizing speed advantages utilized by latency arbitrageurs, LTAD is
designed to ensure that liquidity providers resume achieving their
goals with respect to their liquidity provision strategies on CHX that,
prior to January 2016, resulted in valuable liquidity in securities
such as SPY being provided to the marketplace.\91\ \92\ In addition,
LTAD would facilitate the achievement of such goals while having a de
minimis impact on random liquidity takers not engaged in latency
arbitrage activities.\93\
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\91\ See supra note 11; see also supra Appendix A.
\92\ Since the Entry Event, the Exchange has observed latency
arbitrage activity in other S&P-correlated securities traded on CHX,
which has also negatively impacted displayed liquidity in those
securities.
\93\ See supra note 19; see also supra Appendix C.
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In finding that the rules pertaining to the IEX Delay did not
permit unfair discrimination, and would not impose any unnecessary or
inappropriate burden on competition, the Commission recognized that
displayed limit orders or non-pegged non-displayed limit orders, the
types of liquidity LTAD is designed to protect, would not benefit from
the symmetric IEX Delay \94\ because the purpose of such limit orders
is to post or execute consistent with their fixed limit price, as
opposed to being repriced by an exchange based on changes to the
NBBO.\95\ When also considering that displayed limit orders and non-
pegged non-displayed limit orders -1- are as vulnerable to latency
arbitrage attacks as pegged orders \96\ and -2- could only be
effectively adjusted by the liquidity provider itself in response to
market changes if such orders are provided as part of a broader
liquidity provision strategy that utilizes proprietary algorithms to
price and size such limit orders,\97\ it logically flows that the best
way to protect such valuable displayed liquidity \98\ is through an
asymmetric delay, such as LTAD, that empowers liquidity providers to
more efficiently execute their liquidity provision strategies that
result in valuable displayed liquidity being provided to the
market.\99\ Thus, given the importance of this displayed liquidity and
the ineffectiveness of symmetric delays in protecting limit orders from
latency arbitrage, the Exchange believes that LTAD is narrowly-tailored
to address latency arbitrage as applied to limit orders and, thus, any
discrimination between liquidity providers and liquidity takers is
justified and consistent with the requirements of the Act.\100\
Further, LTAD will be applied to all Participants, thus all
Participants that provide liquidity in securities subject to LTAD \101\
will be able to benefit from the LTAD.
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\94\ See IEX Approval Order, supra note 16, at 41157.
\95\ See id.
\96\ See supra note 3.
\97\ See supra note 10.
\98\ See supra Appendix A.
\99\ See supra notes 11 and 12.
\100\ The Exchange further notes that discrimination between
liquidity providers and liquidity takers, in furtherance of the
objectives of the Act, is not without substantial precedence in the
NMS. The Commission has previously approved various initiatives that
discriminate between liquidity providers and liquidity takers. For
example, many national securities exchanges, including CHX, utilize
the ``maker/taker'' fee model, which discriminates between liquidity
providers and takers for the purpose of incentivizing market
participants to provide liquidity to, and/or take liquidity from,
the exchange, depending on the exchange's specific implementation.
See e.g., Bats BYX Fee Schedule; see also Section E.1 of the CHX Fee
Schedule. Similarly, the CHX offers a Market Data Revenue Sharing
program, whereby only certain liquidity providers could receive a
market data revenue rebate in proportion to the quality of liquidity
provided. See Section P.1 of the CHX Fee Schedule. In fact, the IEX
Delay discriminates between liquidity providers with resting pegged
orders and liquidity takers, thereby necessarily discriminating
between liquidity providers that utilize pegged orders and those
that do not utilize pegged orders.
\101\ See supra note 37.
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For similar reasons, the Exchange also believes that the proposed
rule change is consistent with Regulation NMS as LTAD would constitute
a de minimis intentional access delay and is thereby consistent with
the requirements of Rule 600(b)(3) of Regulation NMS.\102\ Moreover,
the Exchange further believes that LTAD is consistent with Rule 611
\103\ and Rule 610(d) of Regulation NMS.\104\
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\102\ See 17 CFR 242.600(b)(3).
\103\ See 17 CFR 242.611.
\104\ See 17 CFR 242.610(d).
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Specifically, the Exchange believes that the proposed rule change
is consistent with the ``immedia[cy]'' requirement of Rule 600(b)(3) as
LTAD is a de minimis intentional access delay and thereby compatible
with the Exchange having an ``automated quotation'' under Rule
600(b)(3) and thus a ``protected quotation'' under Rule 611.\105\ Given
that LTAD would enhance liquidity and optimize price discovery in NMS
securities, would apply to all Participants and would not unfairly
discriminate among Participants as it is narrowly tailored to minimize
the effectiveness of latency arbitrage strategies with respect to limit
orders, all in furtherance of the objectives of Section 6(b)(5) of the
Act, as discussed above, the Exchange believes that LTAD would not
impair fair and efficient access to the Exchange's protected
quotation.\106\
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\105\ See Final Interpretation, supra note 9, at 40792.
\106\ See id.
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Moreover, the Exchange believes that LTAD is consistent with the
requirements of Rule 611.\107\ As described above,\108\ a portion of a
Routable Order may be immediately routed away to execute against away
protected quotations, with the unrouted remainder being delayed before
being permitted to execute against an order resting on the CHX book at
a price inferior to the away protected quotations by relying on the
proposed Immediate Feedback derived from the immediate routed portion
to ignore the away protected quotation. Given that LTAD is de minimis
in the context of Rule 600(b)(3), it logically flows that LTAD should
also be considered de minimis for the purposes of the ``simultaneously
routed'' Intermarket Sweep Order (``ISO'') requirement under Rule
611(b)(6). Thus, the Exchange submits that a delay caused by LTAD
between the routing of one or more ISOs to satisfy better priced
protected quotation(s) and the delayed execution of a related order
through such protected quotation(s) is consistent with the requirements
of Rule 611(b)(6).
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\107\ 17 CFR 242.611.
\108\ See supra Example 3.
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Similarly, a portion of a Routable Order may be immediately routed
away to execute against away protected quotations with the unrouted
remainder being delayed before posting to the CHX book at a price that
crosses such away protected quotations. This could result if the
resting order on the CHX book that resulted in the unrouted remainder
being delayed was cancelled before the unrouted remainder were released
from LTAD. Under this scenario, given that LTAD is de minimis in the
context of Rule 600(b)(3), it logically flows that the de minimis delay
caused by LTAD
[[Page 65458]]
between the routing of one or more ISOs to satisfy away protected
quotations and the actual display of the related order at a price that
crosses such away protected quotations is permissible and consistent
with the requirements of Rule 610(d).\109\
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\109\ See ``Division of Trading and Markets: Responses to
Frequency Asked Questions Concerning Rule 611 and Rule 610 of
Regulation NMS.'' U.S. Securities and Exchange Commission, 4 April
2008. Web. 20 June 2016 http://www.sec.gov/divisions/marketreg/nmsfaq610-11.htm (``Question 5.02''); see also CHX Article 20, Rule
6(c)(3).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act. To the contrary, the
Exchange believes that any burden on competition is necessary and
appropriate in furtherance of the purposes of Section 6(b)(5) of the
Act because LTAD is functionality that seeks to enhance liquidity and
optimize price discovery by deemphasizing speed as a key to trading
success in order to further serve the interests of investors and
thereby removes impediments and perfects the mechanisms of a free and
open market.\110\
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\110\ See supra note 15.
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The Exchange further notes that market participants will continue
to be able to obtain CHX book data via the SIPs or through the
Exchange's proprietary book feed, the CHX Book Feed,\111\ without delay
as the Exchange does not propose to delay any outbound messages or
market data. As such, the Exchange submits that any burden on
competition, while necessary and appropriate in furtherance of the
purposes of that Act, has been minimized.
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\111\ See CHX Article 4, Rule 1.
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C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
No written comments were solicited or received with respect to the
proposed rule change.
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 (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve or disapprove the 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-CHX-2016-16 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-CHX-2016-16. 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 Web site (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 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 Web site 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 such filing will also be available
for inspection and copying at the principal office of the Exchange. All
comments received will be posted without change; the Commission does
not edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly. All
submissions should refer to File Number SR-CHX-2016-16 and should be
submitted on or before October 13, 2016.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\112\
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\112\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-22790 Filed 9-21-16; 8:45 am]
BILLING CODE 8011-01-P