February 3, 2003
Mr. Jonathan G. Katz
The Securities and Exchange Commission
Dear Mr. Katz:
I only have one concern about the BOX's current proposed rules. This concern revolves around the Price Improvement Process (PIP).
PIP is an innovative concept but it must not deter outside competition. Currently the rule is structured so that the customer side of the order is NOT viewable via the NBBO (and competing orders in the PIP process are also invisible). This will create many problems for any outside competitors. It is very important that all outside market participants have a fair opportunity and incentive to compete on an equal basis with the order flow brought to the Exchange.
The BOX has said "that is not their intention to hide anything from market participants" but claims OPRA is actually the problem. The BOX has told me that they would be willing to allow the customer side of PIP's (and competing orders) to be viewable to all, however OPRA claims that there may be technical issues with showing these quotes in the NBBO.
It is vital that all participants know when a PIP is in process and the best way to disseminate this information is via the posted quote in the NBBO. In such cases, the customer side plus the competing orders would show up in the NBBO. OPRA should also send out a "non auto executable flag" with these PIP quotes.
Competitive Issues if the PIP is not viewable to all
Customers who send better priced limit orders to the BOX (or anywhere else) may be shut out of any opposite tradable order flow. Under the current PIP rules, BOX participants can step in front of customer limit orders without the customer even knowing. In essence these bids/asks in a PIP are invisible to outside participants as they are NOT viewable in the NBBO. Thus customers who post the National BEST bid/ask on the BOX may not get filled if opposite order flow enters the market. All they would see is trades taking place at a price slightly better than their posted quote.
This in affect will not reward those who post the best markets Nationally as BOX participants can always step in, a "tick better" than anyone else.
For example, let say an option has a NBBO of $7.00 bid $7.40 ask. If an outside liquidity provider enters a $7.10 bid and another customer (liquidity taker) enters an order to sell at $7.10, the order could be routed via a PIP and trade at $7.11. This could take place all day. The liquidity provider ($7.10 bid) may be the BEST bid ALL day and every time a sell order enters the market it could trade via an invisible PIP shutting the outside liquidity provider out. If he knew sell orders were present then he too could compete in the PIP process.
One might argue that the customer taking liquidity will get "a tick better" but one should realize that if outside liquidity providers are constantly being shut out, then one should expect that they will likely be driven from the marketplace creating wider spreads overall making the market worse for everyone including liquidity takers. The bottom line is that, the more independent liquidity providers (whether market makers or outside participants) the better the market for all liquidity takers.
This issue is not simply a BOX issue as customers/market makers on other Exchanges can be shut out even if the National best bids/asks are on other Exchanges. This can happen because PIP's can take place on the BOX even if the BOX isn't posting the National Best bid or ask at the inception of a PIP.
The overall rules of the BOX are an improvement over the other five Exchanges. However, in order for the market to be truly competitive, OPRA must display the quotes resulting from the PIP process so that all markets are visible to all participants.
A compromise to this issue would be to approve the BOX's rules with the exception of their PIP rules until OPRA has the capability of distributing PIP quotes in the NBBO or the existing rules could be approved as long as OPRA sets a timetable to fix whatever technical issues they have displaying PIP quotes in the NBBO.