When Congress mandated a national market system (“NMS”) for trading securities in 1975, it emphasized that consolidated data “would form the heart of the national market system.” The Commission since has emphasized the importance of the consolidated data feeds on many occasions, including in its January 2010 Market Structure Concept Release: “As a result, the public has ready access to a comprehensive, accurate, and reliable source of information for the prices and volume of any NMS stock at any time during the trading day. This information serves an essential linkage function by helping assure that the public is aware of the best displayed prices for a stock, no matter where they may arise in the national market system.” In addition to providing the view of the market for many investors, consolidated data feeds also play an important role in price discovery and compliance functions. For example, a number of exchanges and other trading centers use the consolidated feeds to check prices at other trading centers to determine whether they may execute an order or whether another trading center has a better price.The last sentence is particularly stunning, because we have published an abundance of evidence that clearly establishes that exchanges and trading centers are not using the consolidated feeds to determine whether they may execute an order or whether another trading center has a better price. The first clear example of this violation was published in a satire titled HFT Breaks Speed-of-Light Barrier, Sets Trading Speed World Record. Here, are, just, a, few, more, examples, though one can find occurrences every trading day. In fact, they are so prevalent, occurring hundreds of times a day, that we wrote another paper questioning Is The NBBO Being Ignored?, and yet another wondering if Regulation NMS Has Been Rescinded.
The disparities in data transmissions that Rule 603(a) prohibits can have important consequences that risk undermining investor confidence and interfering with the efficiency of the markets. For example, a delay in the release of data to the consolidated feeds in contrast to the proprietary feeds can cause an investor relying on the consolidated feeds to make a trading decision based on a potentially stale picture of current market conditions. An exchange’s delay in sending its quotes to the consolidated feeds also can cause inefficient execution decisions at other market centers and, under some circumstances, create the appearance of a “crossed” national best bid and offer (“NBBO”), which occurs when the best bid exceeds the best offer. The appearance of a crossed NBBO can cause both uncertainty and the risk of a trade being executed at worse than the best available price. 6
6 A crossed NBBO triggers an exception to the trade-through rule of Regulation NMS. See Rule 611(b)(4) of Regulation NMS, 17 CFR § 242.611(b)(4).From Regulation NMS Rule 611(b)(4) Exceptions to Order protection rule:
(4) The transaction that constituted the trade-through was executed at a time when a protected bid was priced higher than a protected offer in the NMS stock.
What this means is that when the NBBO is crossed (the best bid price is higher than the best offer price), exchanges do not have to route orders and are free to execute trades locally, regardless if better prices exist elsewhere. How often is the NBBO crossed? It depends greatly on market activity. During news announcements, there can be 500 to 1,000 or more crossed NBBO quotes. The lowest number of crossed quotes ever seen in a minute (during quiet trading) is about 25.
Crossed NBBO quotes may be one cause of the dozens of micro flash-crashes we see in stocks every day. If a large orders appears while a stock has a crossed quote, the order could execute against the local book (depriving it of liquidity on other exchanges) leading to a sudden price drop (or rise). It is both curious and incongruous that the SEC then goes out of their way to write on page 7:
Although the data delays came to light during the inquiry regarding the Flash Crash, the delays occurred after the start of the Flash Crash and did not cause the extreme volatility that day.We strongly disagree and would like to see what evidence (if any) they have to make such a bold claim.
The Commission has recognized that, due to the consolidation process (i.e., the time from the receipt by the Network Processor of the information from exchanges to the time it distributes consolidated information to the public), information from a Network Processor generally reaches market participants later than information from exchanges’ proprietary feeds. See Concept Release, 75 Fed. Reg. at 3601 (citing an average consolidation time of approximately 5-10 milliseconds). Nevertheless, exchanges have an obligation under Rule 603(a) to take reasonable steps to ensure—through system architecture, monitoring, or otherwise—that they release data relating to current best-priced quotations and trades through proprietary feeds no sooner than they release data to the Network Processor, including during periods of heavy trading.To dispel this myth, we spent considerable time and effort creating an animation tool that illustrates how all market participants (even one subscribing to direct feeds only) would have to replicate this consolidation process.
|This video shows 11 exchanges
trading one stock. The box at 6 o'clock represents the network processor or SIP. The
other boxes each represent one exchange trading this stock. The lines connecting
the boxes represent direct feed connections. As you can see, any entity connected
to each exchange must essentially replicate the consolidation
process performed by the SIP.
The SIP shows the National Best Bid/Offer. Watch how much it changes in a fraction of a second. The shapes represent quote changes which are the result of a change to the top of the book at each exchange. The time at the top of the screen is the time of the last quote or trade update in Eastern Time HH:MM:SS:mmm (mmm = millisecond). We slow time down so you can see what goes on at the millisecond level. A millisecond (ms) is 1/1000th of a second. The blink of an eye is about 200 ms. Note how every exchange must process every quote from the others -- for proper trade through price protection. This complex web of technology must run flawlessly every millisecond of the trading day, or arbitrage (HFT profit) opportunities will appear. It is easy for HFTs to cause delays in one or more of the connections between each exchange.
We can infer from the SEC Order that the two systems pointed to by the green arrow must
somehow be connected.
From page 4 of the SEC Order:
NYSE receives hundreds of millions of orders to buy or sell securities each trading day. These orders and related message traffic go to NYSE’s matching engine, known as the Display Book, or “DBK,” for processing. DBK matches orders and generates executions, redirects orders for routing to other exchanges, and maintains limit orders in NYSE’s “order book” for possible future execution.
and from paragraph 1 of the same order:
..a number of exchanges and other trading centers use the consolidated feeds to check prices at other trading centers to determine whether they may execute an order or whether another trading center has a better price.In other words, the SEC has stated that exchanges must use the consolidated feed to check prices when determining order routing, and we know from the SEC diagram that the "DBK" system at the NYSE is what redirects orders for routing to other exchanges. But we highly doubt this is how routing actually works.