Speech by SEC Commissioner:
Statement at Open Meeting to Propose Amendments to Eliminate Flash Orders
Commissioner Troy A. Paredes
U.S. Securities and Exchange Commission
September 17, 2009
Thank you, Chairman Schapiro.
Today's rule proposal would ban flash orders. Various concerns have been raised about flash orders recently. Most notably, flash orders have been characterized as creating a "two-tiered market" that privileges certain market participants at the expense of the broader investing public. This concern rests on the understanding that, through proprietary data feeds, flash orders are shown to select market professionals who are uniquely able to respond to flash orders because of their technological capabilities.
Critics of flash orders also have said that flash orders can disadvantage investors whose orders are flashed. For example, if an investor's order is not filled when flashed, the market price may move against the investor during the delay of the flash before the order is routed to another trading venue. A flash order also may reveal information about an investor's trading interest that the other side of the market could use against the investor whose order is flashed.
In addition, flash orders are said to discourage displayed liquidity and aggressive quoting. The argument is that flash orders allow market participants to interact with marketable orders without having to display liquidity and attract order flow by offering a more competitive price. The flip side of this concern is that flash orders may deprive investors who have displayed their liquidity rapid execution. Market participants who respond to flash orders have been viewed as "stepping ahead" of investors who quote publicly.
These and other concerns are appreciable, but they provide an incomplete portrayal of flash orders. A thorough and unbiased assessment of flash orders must account for the potential benefits of flash orders that are lost if a ban is imposed.
The proposing release identifies the following benefits of flash orders. These benefits help explain why there is a market for flash orders in the first place.
First, flash orders may induce liquidity from those who are unwilling to have their quotes displayed publicly. This in turn may create opportunities for better execution.
Second, flash orders may be executed for lower fees than markets charge for executing against displayed liquidity. Indeed, executed flash orders earn a rebate in some trading venues instead of paying a fee.
Third, investors who are unwilling to display may reduce their transaction costs by responding to flash orders.
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These highlights of certain pros and cons of flash orders build to the key question: What's the net market impact of banning flash orders? It is important to consider the details of market structure and market participant behavior when evaluating this question. This includes recognizing differences between equity markets and options markets.
I support today's proposal, but am mindful that a ban is an unequivocal step. I look forward to considering the comments we receive, including any data that commenters can provide. I would especially welcome any data commenters can provide demonstrating how the current low volume of flash order trading has impacted securities markets.
Further, I am keenly interested in comments that address whether there are less restrictive alternatives to a ban that may strike a more appropriate balance. For example, would requiring that flash orders be made available to any market participant free of charge address the "two-tiered market" concern, even if responding to flash orders in practice requires certain technological capabilities in which not all market participants have invested? Would requiring that an order can only be flashed by a broker with the consent of the investor submitting the order remedy concerns that flash orders may disadvantage the investor whose order is flashed? What if instead of banning flash orders, flash orders were required to offer some form of price improvement?
Let me conclude by broadening the discussion beyond flash orders with an overarching point that should be part of any analysis of our markets: Exchanges and other trading venues need flexibility to innovate new products, services, and trading opportunities that advance the varied interests of market participants by affording them choice. Investors are the ultimate beneficiaries when innovation spurs robust competition among different trading venues. Likewise, investors and brokers expect that they will be rewarded when they invest in the latest technology and develop their skills to gain a market edge. When the regulatory regime erodes a market participant's opportunity to profit from its legitimate competitive advantage, the incentive to innovate is dampened.
Simply put, we need to guard against imposing regulatory constraints that unduly discourage innovation and competition.
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I join my colleagues in thanking the staff — particularly those from the Division of Trading and Markets and the Office of Economic Analysis — for their hard work on this release.