The SEC’s ATS Transparency Rules: What’s the Impact?

By Ivy Schmerken, Editorial Director

The SEC’s new proposed rules on transparency in alternative trading systems are going to shine a light on the operations of dark pools, ensuring fair access to information for all market participants.

The SEC’s proposed rule on Regulation of NMS Alternative Trading Systems would formally create a disclosure regime along with a new form Reg ATS-N and a process for filing amendments.

Clearly, investors are the winners because they will gain access to detailed information about ATS trading services, fees, market data, order types, and algorithms.

In return for filing this form, ATSs are granted an exemption from the more burdensome regulations imposed on exchanges.

As the industry moves in the direction of enhanced disclosure for the once secretive dark pools, the amount of information could skyrocket.

“If there is any risk, the risk is more to our collective eyesight,” said Adam Sussman, head of market structure and industry partnerships at Liquidnet. Speaking on a call held by the Securities Traders Association, Sussman estimated that Reg ATS-N could result in an extra 2,000 pages of filings by ATSs.

“There is going to be an incredible amount of paperwork that market structure geeks like myself ,as well as legal and compliance, are going to have to pour over,” he said. “While paperwork is not the worst outcome, it obviously reflects the magnitude of additional detail that will be required,” he said.

But what is the impact going to be on ATSs reporting this information? Will NMS stock ATSs lose some of their proprietary edge? What is the SEC going to do with all of this data? Could these ATS disclosures result in behavioral changes by market participants?

Here are 12 takeaways on ATS transparency regulations and the impact of boosting dark pool disclosures:

1. Time for an Update

The premise behind overhauling the ATS rules is that dark pools are due for a refresh. Regulation ATS has not been updated since 1998. Yet, there have been a number of technology-driven changes in market structure and competition, speed and sophistication of participants.

2. ATSs Increase Clout

Given that 40 or so ATSs now account for approximately 15 % of the total shares traded, they have a significant role in the capital markets. “That figure represents a more than fourfold increase since 2005, when ATSs accounted for roughly 4% of NMS stock trading,” stated SEC Commissioner Louis Aguilar during opening statements at the Nov. 18 meeting.

3. ATS Disclosure Is No Threat to Innovation

While some may worry that opening the kimona on ATSs could divulge a proprietary advantage, electronic equity trading is a mature industry.

“The ATS industry, largely comprised of dark pools, have matured at this point, where the increase in operational transparency outweighs the risk of any threat to innovation,” said Liquidnet’s Sussman.

4. A Lot of Data is Public Already

The idea of ATS disclosure is not new. Currently, about a dozen ATSs make their Forum ATSs public on their respective web sites. There is a demand for this ATS information and that is why these firms are releasing it.

Meanwhile, 35 ATSs are providing weekly aggregate volumes by symbol, number of shares and trades under FINRA’s ATS Transparency initiative. However, volumes are reported with a lag of two weeks for tier 1 NMS stocks and a lag of four weeks for tier 2 NMS stocks. As a result, the public is able to see the total shares traded each week by security in each ATS or dark pool.

5. Information Explosion

“The amount of information added will dramatically increase the size of any form ATS,” said Sussman. In the interests of transparency, brokers will want to make public anything they do for customers. Contributing to the volumes of disclosure will be firms that operate complex businesses. Take a firm that owns a market maker, an agency facilitation desk and an algo desk, with different people sitting in different rooms and different buildings. “The way that each of these desks access the ATS are going to have to be disclosed,” advised Sussman. All of this will add to disclosures. Once this information is in-house, there are many paths that the SEC can go down, such as looking at how each desk interacts with the ATS, which order types are offered, which data feeds gets form the ATS and where the smart order routers are located in relationship to the matching engine.

6. Stay Tuned for More Statistics

Though no new statistics related to executions are being requested, ATSs can no longer provide data selectively to subscribers. “If an ATS provides aggregate, platform-wide, market quality statistics to one or more subscribers, that data will need to be made public as part of Form ATS-N,” explained Sussman. “It will need to list and describe the categories of the aggregate platform-wide order flow and execution statistics and describe the method used to calculate its metrics.”

7. Identifying Conflicts of Interest

The SEC will be looking to spot potential conflicts of interest, which could arise when the business interests of the broker-dealer operator or its affiliates compete with the interests of market participants that access and trade on the ATS. “These types of conflicts of interest lay at the heart of several enforcement cases brought by the SEC and other regulators,” stated Commissioner Aguilar. “For example, the proposal would require operators of covered ATSs to disclose whether they or any of their affiliates are submitting trades to the ATS, either on a proprietary basis or otherwise,” said Aguilar. ATSs must also disclose their policy on protecting the confidentiality of subscriber information.

8. Disclosure Regime

An important change is that the SEC is establishing an explicit approval process for an ATS-N filing and for subsequent amendments that can occur. If a venue is filing Reg ATS-N for the first time, the SEC has 120 days to review it and deem it effective or ineffective, noted Sussman. An incumbent ATS would be grandfathered in and be allowed to operate, but would need to file Reg ATS-N. An amendment to Reg ATS-N has to be filed 30 days in advance, and the SEC has 30 days to deem it effective or ineffective. This adds another 10 days to the current 20-day period for amendments.

9. Consolidation Unlikely

Most of the larger ATSs owned by global investment banks have already disclosed information because they’ve been involved in settlements or ongoing dark pool investigations. “This will add to the amount of information made public, but not in a way that would cause them to want to shut their pool down,” observed Sussman. Also, sell side firms save money by matching buy and sell orders in dark pools rather than paying fees to exchanges.

10. Treasury ATSs on the Horizon?

While the proposed Reg applies to NMS stock ATSs, it does not impact the burgeoning field of fixed income ATSs. The SEC asked the industry about 100 questions for their thoughts. One example is should Treasury trading venues become ATSs? In a comment letter, market maker and liquidity provider Virtu Financial, wrote: “We believe that Regulation ATS should be amended to include electronic platforms for U.S. government securities.

11. Sifting through the Paperwork

One of the questions raised on the STA call by Sussman is does the SEC have the staff to sift through all of the ATS-N filings, particularly in the first year when there could be a backlog.

12. Order Routing

Ultimately once everyone digests the inner workings of ATSs, participants will be armed with more information and be in a position to shift a larger percent of their business toward the ATSs that benefit their business. However, there isn’t anything in the regulation to suggest that participants will move more of their volume toward lit markets, said Sussman.

If the proposed amendment of Reg ATS is implemented, dark pools will be required to share information with the public, just as when a company files for an IPO. This means that “all participants will have fair access to critical operational information for each ATS, ” wrote Virtu in its comment letter, endorsing the proposed changes. Market structure experts will be able to slice and dice the filings to compare and contrast the venues by types of order types, algorithms, fees and other criteria. As the SEC amasses more information on dark pools, the agency will have the data to identify patterns among the venues, and improve their oversight. Buy side firms should benefit from the new era of big data on dark pools, as they use it to improve their trading decisions.