The SEC rejected a Cboe EDGA Exchange, Inc. ("EDGA" or the "Exchange") rule proposal to introduce a liquidity provider protections delay mechanism. According to EDGA, the proposal would protect liquidity providers and foster better markets in equity security traded on EDGA.
The proposal would (i) delay EDGA's incoming executable orders for up to four milliseconds while allowing resting orders on EDGA's book to be canceled or revised without the delay, and (ii) permit liquidity providers on EDGA to modify resting quotations in accordance with other market data prior to the quotes being otherwise executed against other incoming orders.
As previously covered, the SEC Office of the Investor Advocate ("OIA") criticized the proposal for favoring market participants that submit a certain set of orders to EDGA, which would appear inconsistent with investor protection. In addition to being "discriminatory on its face," the OIA argued, the proposal "is insufficiently designed to enhance market quality."
EDGA argued that the proposed delay would result in increased displayed liquidity with tighter spreads and greater size on the Exchange and, conversely, that rejecting the proposal would cause liquidity providers to enter quotes with either a wider spread or a smaller size than they otherwise would display. By contrast, opponents argued that the speedbump would result in a decrease in fill rates as liquidity providers "fade away" from posted quotes.
The SEC concluded that EDGA did not fulfill its burden to prove that the proposed delay mechanism is consistent with the Securities Exchange Act and, specifically, with Section 6(b)(5) ("National Securities Exchanges"). The SEC argued that EDGA did not sufficiently demonstrate how the proposal would (i) facilitate a free and open market and a national market system, (ii) ensure "just and equitable" trade principles, and (iii) protect market participants from unfair discrimination between customers and broker-dealers.
Commentary Bob Zwirb
Although the parties framed the issue here in terms of whether the proposed speedbump would improve execution quality for investors (as Cboe maintained) or instead would result in "unfair" discrimination (as the SEC concluded), the real issue, as articulated by the exchange, appears to be whether the nation's third largest exchange should be free to offer investors a different form of trade execution - one that makes a "tradeoff between the speed of an execution and other factors, such as price improvement and liquidity." If there is a market for this kind of tradeoff, as Cboe thinks there is, what is the harm in allowing the exchange to offer it, or at least to experiment with it? If not, or if it wouldn't work in practice as positively as Cboe predicts it would, wouldn't this result in business being shifted to other stock exchanges, including numbers 1 and 2?
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