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United States : IEX begins Operation as an Exchange Following Interpretive Guidance Adopted by the SEC.

On September 2, 2016, the Investors' Exchange, LLC (IEX) commenced full operations as a registered national securities exchange. After receiving over 400 comment letters during the The U.S. Securities and Exchange Commission's (SEC) review and a spirited debate on equity market structure, the SEC approved IEX's application to become a national securities exchange on June 17, 2016.1 As highlighted in the widely read book Flash Boys, by Michael Lewis, IEX employs a speed bump or delay on market participants accessing liquidity on IEX (IEX access delay).

Contemporaneous with approval of IEX as an exchange, the SEC adopted interpretative guidance that would allow an exchange to impose certain delays in access its quotations and still have such quotations remain "protected" within the meaning of Regulation NMS (Interpretive Guidance).2 The adopted Interpretive Guidance will allow quotations on IEX to be treated the same as quotations on any other automated exchange despite the IEX access delay. Other exchanges, such as the Chicago Stock Exchange, Inc.,3 the NASDAQ Stock Market LLC,4 and the New York Stock Exchange LLC (NYSE) and its affiliated exchanges,5 have announced that they are contemplating adoption of intentional access delays of their own.

The summary below provides a brief overview of the SEC's Interpretative Guidance and highlights some of the unique features of IEX.

The IEX access delay requires IEX exchange members to connect to IEX through an IEX "Point of Presence"(IEX POP) that imposes a 350 microsecond delay or speed bump on member communications sent to the IEX trading system. The IEX POP also imposes an additional 350 microsecond delay on communications from the IEX trading system back to members, resulting in a total round trip delay of 700 microseconds for an IEX member to receive acknowledgment of how its order was handled (e.g., executed, posted, rejected, etc.). The stated purpose of the IEX access delay is to equalize access among IEX members and prevent an individual IEX member from having a speed advantage over others in accessing quotations on the IEX.

Prior to adoption of the SEC's Interpretive Guidance, an exchange may not have been permitted to impose an intentional delay in access to the exchanges quotations while still having those quotations considered to be "protected" under Regulation NMS and accompanying guidance. In general, if a quotation is considered protected, other trading centers must honor that quotation by not executing trades at inferior prices, also known as "trading through," the protected quotation pursuant to the SEC Rule 611 (the Order Protection Rule).6

In other words, if an exchange's quotes are considered protected and represent the national best bid or national best offer (NBBO), i.e., the best available price to buy or sell a particular security, market participants must generally either match that price in executing trades in that security on other trading centers or route to execute against the protected quotation on the exchange displaying it. If an exchange's quotations are not considered protected, market participants may be able execute trades at inferior prices to those displayed on that exchange.7 Accordingly, without protected quotation status, IEX would likely have been a less attractive venue for market participants to submit aggressively priced quotations, i.e., those at or better than the NBBO, because market participants have ignored these quotations.

Under Rule 600 of Regulation NMS a protected quotation must be, among other things, an "automated quotation."8 An "automated quotation" generally requires that a quotation "immediately and automatically" execute, cancel, transmit a response to the sender, or display updated information regarding the quotation.9 In adopting Regulation NMS in 2005, the SEC explained that " t he term 'immediate' precludes any coding of automated systems or other type of intentional device that would delay the action taken with respect to a quotation."10

In order to accommodate IEX's goal of having protected quotations, the SEC proposed interpretive guidance on March 18, 2016, that would have provided that intentional delays of less than one millisecond are de minimis and would not impair a market participant's ability to access a quotation.11 The SEC stated, at the time, that adopting this proposed guidance "could encourage innovative ways to address market structure issues."

In adopting the Interpretive Guidance, the SEC backed away from the originally proposed one millisecond standard for intentional delays that could still allow quotations to be considered automated and therefore protected. Instead, the SEC adopted a more qualitative standard that may change over time as technology evolves. The SEC stated that it believes it is necessary to update its interpretation of the term "immediate" in Regulation NMS in response to technological and market developments that have occurred over the last 10 years.

Specifically, the SEC will assess whether an intentional delay is "so short as to not frustrate the purposes of the Order Protection Rule by impairing fair and efficient access to an exchange's quotations." Thus, if an intentional delay meets this standard, the intentional delay will be considered de minimis and therefore "immediate" for the purposes of SEC Rule 600(b)(3) (defining "automated quotation") and the Order Protection Rule. In other words, quotations for which there is a de minimis intentional delay in access will still be considered immediately accessible and therefore an automated quotation that is protected. The SEC will consider each access delay proposed by an exchange individually to determine whether it meets the de minimis standard.

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Publication:Mena Report
Date:Sep 7, 2016
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