Moody's Chimes In On The Consequences Of The Flash Trading Ban
In their weekly commentary piece, among many other things, Moody's discussed the downstream impacts of the ban of Flash, IOIs and other existing practices. They provide a different perspective in terms of a pros/cons analysis of the upcoming changes to both brokers-dealers and exchanges. Nothing earth shattering, but useful information to keep a sense of perspective in light of upcoming market structure developments, and who stands to lose the most.
More relevant to us seems the question of whether a ban on “flash” orders would be a precursor of more changes in the market structure. The modern U.S. cash equities market is a highly complex network of electronic trading platforms with a myriad of order types, order flow aggregation mechanisms, and pricing schemes. As a whole, the market is also very liquid and extremely competitive. The pricing pressure exerted on exchanges by brokers and traders trying to keep their execution costs down is intense.
A major component of the market’s competitiveness stems from the fact that over 30% of total U.S. cash equities trading takes place away from exchanges, and about 50% away from NASDAQ OMX and NYSE Euronext – the two major exchanges. Much of this order flow is either “internalized” by major brokers or is directed to “dark pools,” which are a type of ATS. As with “flash” orders, the traders and platforms executing trades via these means benefit from the price discovery that occurs on “bright” venues (e.g., exchanges), which post visible firm quotes to the NBBO. But none of these trading venues contribute to price discovery.
Furthermore, there are other reasonably common market practices, such as the so-called indication-of-interest (IOI) orders, which are used to link dozens of dark pools among themselves and with other venues, that function in ways that are similar (though, not identical) to “flash” orders and could therefore be subjected to similar criticisms. [TD: this statement agrees with the thoughts presented yesterday by Credit Suisse, and represented earlier by Zero Hedge]
Were market practices such as internalization and “dark pools” also to be prohibited or made significantly less attractive – perhaps, on the grounds similar to those that may apply to “flash” orders – this could change the industry’s competitive landscape in a major way. It would shift an important degree of pricing power to exchanges and away from brokers and traders. All other things being equal, this would generally be positive for the credit profiles of exchanges and could be negative for institutional brokers.