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Micro-Structure & Exchanges: A Complicated Relationship

Micro-Structure & Exchanges: A Complicated Relationship

This past Tuesday night, news hit that BATS Global Markets was in the process of settling with the Securitues and Exchange Comission on the claim that Direct Edge provided unfair perks to certain high frequency traders (HFT), a development that might set a pivotal precedent in the market structure debate.

News of the possible settlement was preceded by the departureof William O’Brien, who ran Direct Edge with its twin exchanges before selling it to BATS in early 2014, becoming the second-in-command of the combined entity.

In an effort to challenge Brad Katsuyama of "Flash Boys" fame live on TV, Brien stated that his exchange’s matching engine (used to match buy and sell orders) used direct feeds provided by other exchanges.

However Direct Edge’s matching system used more stale data from the SIP (securities information processor) - not the direct feeds - for several important housekeeping tasks. In a spectacular public relations failure, the New York Attorney General forced BATS to publicly correct O’Brien’s statements.

One-man crusade

One person in the mix who might have been forgotten is Haim Bodek. After coming out publicly in Scott Patterson’s "Dark Pools" as a critic of exchanges that cater to HFT, Haim was on a one-man crusade to save his reputation by making a convincing case against the HFT industry.

In the end, he wound up triggering SEC investigations that (so far) led to an exchange head being forced to step down. For those unaware, Haim was also the real star of the VPRO film "Wall Street Code." In the film, Haim used the example of skipping in line while buying Metallica concert tickets:

In a phone conversation with Benzinga, Haim noted this (yet to be announced) settlement would set precedent for future concerns about abuses taking place on securities exchanges.  

Symbiotic relationships

Direct Edge wasn’t the only exchange, nor the first exchange, to do what it did, which was the creation of symbiotic relationships between exchanges and HFTs.  

In light of the major events that took place over the past year, aside from announced investigations by the SEC and NYAG, the recent actions taken by U.S. exchanges are suspect, whether they are attempts to engage in damage control or to sweep some things under the rug.

Select Microstructure-Related Events




August 1


Knight Capital $440M loss



Goldman $100M options trading glitch with trades eventually busted

August 22


Nasdaq goes dark for 3 hours (NASDARK)



Hold Brothers Brokerage fined for "spoofing"



The Wall Street Journal runs an in-depth article on Hide-Not-Slide order type



NYSE sued $5M for selling faster data access to special clients



The Problem Of HFT is released by Haim Bodek highlighting "special order types" and exchange abuses



BATS & Direct Edge merger talks surface - Deal takes place so quickly it finishes ahead of schedule



Direct Edge publishes its "Order Type Guide"



Wall Street Code is released



O'Brien misinforms the public about what Direct Edge uses to match orders



O'Brien steps down as President of BATS Global Markets

July 28-29


All US equity exchanges adopt rules on the usage of SIP and direct feeds

August 1


Euronext CEO steps down

August 5


Information about a possible settlement with BATS relating to special order types is reported

The year 2012 was riddled with HFT problems. BATS IPO failure; Facebook launch delayed; seven or eight instances of self-help declarations by several exchanges in August; Nasdaq’s three-hour outage in August; Goldman’s trading glitch; Knight’s trading glitch (affectionately known as the “Knightmare on Wall Street"); and the unprecedented $5 million fine imposed on NYSE for speeding up its private data feeds vis-a-vis the SIP.

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The problems with automation and the systematic issues tied to an unfair playing field couldn’t have been more evident than they were in 2012 (except for 2013 and 2014, that is). Nasdaq’s outage specifically was driven by a message overload problem.

Every time the exchanges expanded the capabilities of their systems to handle higher message rates, HFT would fill the systems back to capacity immediately.

Right now, Direct Edge is in a difficult position, considering that for years the exchange identified Hide-Not-Slide, Pegged and Non-Pegged, Displayed and Non-Displayed options as order types (original doc here):

From the Direct Edge Order-Type Guide (full doc here)

In the 114-page document,the exchange wants those orders redefined to be “characteristics.” That’s a major change.

Interestingly, the announcement about O’Brien stepping down as President at BATS came less than a week after this proposal was filed with the regulators.  It is odd that his exchange would wait so long to clarify what order-types are and what characteristics are.

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Just a few days later, the SEC approved the rules submitted by all eleven equity exchanges chiefly addressing the usage of data feeds, a pivotal issue that is exemplified by the televised clash between Katsuyama and O’Brien.

The regulators explicitly requested these rules in the first place, which explains this flurry of filings and their immediate approval via the “immediate effectiveness” option, but the fact that this ambiguity had lingered on for so long is significant.

KOR Trading Visualization of Filings With Descriptions


Kor Trading offers statistical analysis an visualized breakdown of key filings from exchanges and brokerages.  The group covered the complexity of Direct Edge’s routing structure in an articlepublished August 7.

KOR addresses the retail broker routing growth to Direct Edge for NYSE listings in Q1 and Q2 of 2014:


In 2012, while appearing on Pimm Foxx’s show, O’Brien said he “actively embraced greater government regulation.”  One might wonder how many other exchanges went - and to what extent - to please their HFT clients only to file documentation clarifying what goes on their exchanges only months after Flash Boys made headlines.  p


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Posted-In: BATS Global Markets Direct Edge Haim BodekEducation Topics Top Stories Hot General Best of Benzinga

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