Bloomberg Tradebook LLC
November 7, 2003
Via e-mail: email@example.com
U.S. Securities and Exchange Commission
Re: Commission File No. S7-17-03
Ladies and Gentlemen:
Bloomberg Tradebook LLC ("Bloomberg Tradebook") wishes to comment on the policy statement issued by the Securities and Exchange Commission (the "Commission") setting forth the Commission's view that self-regulatory organizations operating trading markets ("SRO Markets") and electronic communications networks ("ECNs") should apply certain basic principles in their business continuity planning ("the Policy Statement"). The Commission published its Policy Statement for public comment in Securities Exchange Act Release No. 48545 (Sept. 26, 2003), 68 Fed. Reg. 56656 (Oct. 1, 2003).
Bloomberg Tradebook agrees with the Commission's assessment, that "a critical `lesson learned' from the events of September 11, 2001 is the need for more rigorous business continuity planning . . . . " We applaud the Commission's efforts to strengthen the resilience of the securities markets by articulating in its Policy Statement basic principles to be followed by ECNs and SRO Markets in their business continuity planning. We believe, however, that the proposals for business continuity planning set forth in the Policy Statement can and should be augmented and we ask the Commission to consider taking the following steps:
1. The Need for Redundant and Dispersed Facilities
Redundant, geographically dispersed facilities are needed to provide a sound systemic infrastructure for the securities markets. Of necessity, given the centralization of their payment and settlement systems, some elements of the financial services sector must develop and maintain sufficient geographical dispersion to ensure continuity in the event of a major, wide-scale disruption. If not sufficiently dispersed, the DTCC and NSCC facilities risk being single points of failure. The Commission and other regulatory bodies have underscored the need for the regional diversification of these entities' computer back-up sites to secure their continuous operation.
The largest U.S. equity market centers today present similar risks because they are not interlinked with alternative centers. For example, there is nothing approaching redundancy among the New York Stock Exchange (the "NYSE") and the regional securities exchanges and other facilities that offer opportunities to trade NYSE-listed securities. By contrast, in the case of Nasdaq, the recent and rapid growth of alternatives to SuperMontage, particularly including Instinet/Island, the Archipelago Exchange and other ECNs today account for the majority of trading in Nasdaq-quoted securities. If SuperMontage went down, the effects would be far less severe than would be the effects of, say, a disruption at the NYSE.
The events of September 11 have taught us that we should reduce our reliance on single points of failure. As of September 11, multiple electronic trading systems were already widely dispersed. In hindsight, one might even wonder whether the securities markets could not have continued trading during the three days following the attacks on the World Trade Center and the Pentagon. Nasdaq, the regional exchanges and most of the ECNs were not affected at all. The NYSE and its member firms, in contrast, had to overcome major telephone communications, trading floor facilities and other infrastructure damage before trading on its market could resume. Restoring damaged infrastructure by the following Monday was an exemplary accomplishment, but it should not obscure the fact that the bond market opened on September 12, the day after the attack effectively incapacitated the leading bond firm. The NYSE and the American Stock Exchange ("Amex") need not each have been a single point of failure for trading in their listed stocks. It is deplorable that the equity markets could not open until the Monday following the attack.
Nasdaq's Computer Assisted Execution System ("CAES") brings together the trading interest in NYSE- and Amex-listed stocks from third market makers. Similarly, the Intermarket Trading System ("ITS"), in which Nasdaq's CAES system also participates, brings together the trading interest of the primary and regional exchanges. The NYSE could not re-open until Monday, September 17, but Nasdaq's CAES and the regional exchanges, through ITS, could have continued trading in listed securities while the NYSE and Amex restored their facilities. The regional stock exchanges have capacity to take on additional volume in the case of a major outage. The Philadelphia Stock Exchange opened its doors to traders from the Amex, who went there to carry on their business. In addition, several ECNs provided their subscribers with facilities for trading in stocks listed on the NYSE and Amex and were not affected by the September 11 attacks. To be sure, there would have been significantly less liquidity than on normal trading days, but some level of trading could have continued.
2. Interlinked Electronic Markets Provide Maximum Redundancy
The primary goal of business continuity planning for the securities markets should be to provide for trading in listed securities on electronic markets both for floor-based systems and electronic systems that are affected by major disruptions. In the two years since September 11, alternative trading venues for trading listed securities have become more sophisticated and more robust. A highly integrated and geographically dispersed infrastructure of electronically connected market places for trading Nasdaq securities is in place and similar infrastructure is all but in place for trading in exchange-listed securities but for the adoption by the Commission of certain rule changes. Approving rules for quoting listed securities on the NASD's Alternative Display Facility's ("ADF") and expanding the de minimis trade-through pilot rule across all exchange-listed securities would provide a degree of transparency and speed of execution in listed stocks, across the different pools of liquidity in which they can be traded, equivalent to the transparency and speed that currently exist for trading in Nasdaq stocks.
We encourage the Commission to complete its review of the rules for quoting in and reporting listed stocks and then to approve the rules. Requiring ADF participants to provide bilateral connections to each others' systems would facilitate the growth of widely dispersed trading in listed securities and could support continuous trading in NYSE- and Amex-listed securities if those exchanges experienced another major disruption. Today, the ECNs could quote in listed stocks on Nasdaq's CAES but have chosen not to do so because of a second issue that the SEC has only partly addressed, a de minimis trade-through rule.
The Commission implemented a de minimis trade-through pilot rule of three cents for Exchange Traded Funds ("ETFs") in August 2002,1 and this past May extended the pilot through March 4, 2004.2 We strongly encourage the Commission to implement a permanent trade-through rule of five cents across all exchange-listed stocks. Until the implementation of decimal trading on April 9, 2001,3 these stocks traded in minimum increments of one-sixteenth of a dollar, or six and a quarter cents. A de minimis trade-through of five cents would simply encourage market participants to display greater volumes of trading interest from the National Best Bid and Offer through to the price point, five cents away. It would remove much of the contention regarding "pennying" practices and would return the national marketplace to trading practices that existed before the implementation of decimalized quotations.
Improving access for electronic systems to the listed markets would create the same diversity and redundancy that currently exist for markets in Nasdaq securities. As a result, the listed markets would be able to respond to a wide-scale disruption as flexibly and quickly as the markets for Nasdaq securities and the bond markets. To be effective, redundancy and geographical dispersion of facilities would have to be combined with a central coordinating authority in the event of an emergency. We would recommend designating a single decision maker (possibly the Commission itself) as the central point which, in the event of a major disruption, would announce to the entire marketplace which exchanges/markets would be ready to resume trading.
3. Mutual Back-Up Arrangements Are Not Sufficient
In the absence of these rules and the electronic trading in listed securities they would support, trading in listed securities remains highly dependent upon the availability of the primary exchanges and highly vulnerable to significant disruption of their facilities. Trading in Nasdaq stocks today is widely dispersed among Nasdaq's SuperMontage system, several ECNs and an ECN/exchange (Archipelago). Were any of these trading venues to suffer a sustained outage over several days or longer, trading would continue among and between the others, probably without any noticeable effect. The same cannot be said for trading in exchange-listed stocks where current rules, in effect, make the primary exchanges indispensable and subject to an unacceptable level of risk.
The hearings on market structure conducted this week before the Subcommittee on Capital Markets, Insurance And Government Sponsored Enterprises of the House Committee On Financial Services have focused attention on the anticompetitive barriers that the NYSE has erected to protect its market share in NYSE-listed securities.4 We think the Commission's attention should focus as well on ways to reduce or eliminate those barriers if there is to be the truly competitive market the Congress envisioned in the Securities Acts Amendments of 1975. Achieving that goal would also serve the purpose of protecting against another major market interruption of the kind that occurred on September 11.
We are not persuaded that the mutual back-up arrangements promoted and partially tested last year provide a sufficient level of protection for the listed securities markets. These arrangements envision the NYSE trading Nasdaq stocks and Nasdaq's SuperMontage system trading exchange-listed stocks should either market center be incapacitated for a sustained period of time. We understand that both the NYSE and Nasdaq made changes to their systems so that orders in Nasdaq stocks can now be routed to the NYSE by member firms and exchange-listed stocks can be traded on SuperMontage. We respectfully suggest, however, that these arrangements would not provide continued trading facilities.
If Nasdaq's SuperMontage is disabled and the NYSE serves as back-up, one might question whether a specialist, who has never traded a Nasdaq stock, would have either the market knowledge or capacity to handle, from one day to the next, the volumes currently traded in Nasdaq stocks such as Microsoft, Dell and the like. The national market, moreover, would then become bifurcated, with the NYSE trading Nasdaq stocks under its rules (currently, short sale on a last tick and a no trade-through rule) against ECNs and Nasdaq market makers trading the same stocks under their rules (currently, short sale based on a bid test and no rule against trade-throughs).
In the pre-trade processing of orders there are also significant issues that broker-dealers would need to address. For example, order-routing and trade-execution systems are based on security master files, which identify all the characteristics of a security, including the primary exchange or market place. If the operations of either the NYSE or Nasdaq were significantly disrupted, broker-dealer systems would need to make a significant change to their security master files before the next trading day to change the route default from the primary exchange/market place to the back-up facility. To date, the broker-dealers have not been required to make the investment necessary to build and test that capability. Requiring.
In the post-trade processing of trade executions, we believe that the industry would also need to make substantial changes. Orders sent to the NYSE by its member firms result in NSCC contract sheets, which are processed by many broker systems for settlement in one account at DTCC, whereas Nasdaq stocks settle in a separate account. Having Nasdaq stocks appear on listed contract sheets or exchange-listed stocks appear on Nasdaq contract sheets would create a host of settlement problems. To date, broker-dealers have not been required to make changes to their settlement systems to provide for such a contingency and to test their operation.
Adequate contingency planning requires that broker-dealers establish back-up facilities to carry out brokerage functions throughout the trading cycle, from pre-trade through settlement. The Commission's Policy Statement should include a requirement that broker-dealers, as part of their business continuity planning, perform end-to-end testing of their back-up systems for the entire trading and settlement cycle and certify the results to the Commission.
The most important lesson to be learned in the aftermath of the September 11 attacks is the importance of redundant and geographically dispersed facilities and the need to reduce or eliminate single points of failure. We do not believe that the currently proposed mutual back-up arrangements are an adequate response. We believe the Policy Statement should be supplemented and augmented by expanding the trading of listed securities to the ADF, extending the de minimis trade-through rule and encouraging the development of interlinkages among ECNs and SRO Market Centers to reduce the likelihood that the disruption of any one trading venue interrupts our securities markets. In tandem with developing a more geographically dispersed electronic market for listed securities, it will be necessary to designate a central authority to coordinate the resumption of trading in the event of a wide-scale disruption. Finally, it is necessary that broker-dealers have in place adequately tested back-up systems for the entire trading cycle.
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We hope that our letter is helpful to the Commission and the staff in its review of the Nasdaq Proposal. If members of the Commission or of the staff believe we may be of further assistance in these matters, please let us know.
cc: The Hon. William H. Donaldson, Chairman