The guest article by Steve Givot SVP of Strategy & Product Management for Chicago Stock Exchange, Inc. (CHX) was originally published in the June 2015 edition of KOR Group's Market Structure Insights.
CHX SNAP Auctions: A Dark Auction in a Lit Market
In 2014, the Chicago Stock Exchange (CHX) began development on a new process for facilitating the block trading of securities, in response to a market need to address market fragmentation. The goal was to design a functionality, supported by a transparent set of rules, which would attract and consolidate buying and selling interest in a given security at CHX, while minimizing speed advantages, gaming opportunities, and information leakage. The result of CHX’s effort is SNAP (Sub-second Non-disclosed Auction Process) Auctions, which is currently pending review by the U.S. Securities and Exchange Commission (“SEC”).
There have been several unintended consequences of Regulation NMS. One of the most notable is that locating liquidity for a large block transaction has become far more complicated. Several iterations of market response to Regulation NMS have left the marketplace with less displayed liquidity in most issues and fewer readily-identifiable liquidity providers to approach in most issues when working a block size order.
The U.S. equities market is highly fragmented, with the majority of trading centers being “dark pools,” operating under Regulation ATS, with little or no rule transparency. Computational speed has become an important feature in trading. The algorithmic slicing and dicing of large “parent” orders into numerous and smaller “child” orders seeking to mask the existence of the parent order has given rise to claims that the market is unfair and suspect to gaming. Institutions attempting to execute block size orders are heavily focused on minimizing information leakage, which has resulted in increased execution costs. Suffice it to say, market participants wishing to execute block size orders face significant challenges in the current environment. SNAP is well-positioned to address those challenges.
SNAP is an innovative process where CHX, a lit national securities exchange, would transitions into, and out of, a dark auction in a requested security – all in less than one second. If approved by the SEC, SNAP Auctions in a given security could occur numerous times during the trading day, subject to certain timing requirements, and would only be initiated at the request of a market participant. Specifically, a SNAP Auction would begin when CHX receives an order – a SNAP Order – which requests an intra-day auction in a security. CHX would start a SNAP Auction upon receipt of a SNAP Order if the order meets specific time, size, price, and side requirements, as detailed under the proposed CHX rules (additional details are provided at www.chx.com/snap/). Notably, the SNAP Order must be marketable or hypermarketable upon receipt and must meet a minimum size requirement based on the order’s limit price. In short, CHX will only start a SNAP Auction upon receipt of bona fide aggressively priced trading interest of a substantial size.
When CHX announces the start of a SNAP Auction, it will only identify the symbol of the security subject to the SNAP Auction. CHX will not disclose the side, size, or price of the SNAP Order – although it would be clear, by virtue of the requirements to initiate a SNAP Auction, that the order would meet a minimum size requirement and would be priced at or through the contra-side of the NBBO. When CHX starts a SNAP Auction, CHX will go completely dark with respect to the subject security. To this end, CHX will withdraw its quote(s) from the National Market System. CHX will also suspend dissemination of its private book feed (CHX Book Feed) with respect to the subject security and, thus, during a SNAP Auction, the CHX Book Feed will not provide any information for the subject security concerning orders, trades, or any other information aside from that a SNAP Auction is underway in the subject security.
CHX would then assemble orders for the SNAP Auction Book. These orders would come from five sources: (1) the SNAP Order which initiated the SNAP Auction, (2) resting orders in the CHX book at the time the SNAP Order was received (minus orders which were marked to cancel rather than participate in a SNAP Auction), (3) orders responding to the SNAP Auction accepted during the SNAP Order Acceptance (which would last between 475 to 525 milliseconds from the beginning of the auction, randomized to discourage gaming), (4) a collection of SNAP Auction Only Orders, as described below, and (5) the top of book (protected) quote from every other national securities exchange and the Financial Industry Regulatory Authority’s Alternative Display Facility (“FINRA ADF”).
During the SNAP Order Acceptance Period, CHX would not permit any order, including the SNAP order which initiated the SNAP auction, to be cancelled or modified. This aspect eliminates significant gaming opportunities. Immediately after the SNAP Order Acceptance Period has concluded, CHX would (1) calculate a single SNAP Auction price, (2) route Regulation NMS-compliant Intermarket Sweep Orders to other markets to satisfy Rule 611 requirements and/or to satisfy Protected Quotations at the SNAP Auction price if there is an order imbalance on the SNAP Auction Book (if applicable), (3) wait for responses to routed orders (if necessary), and (4) cross the remaining size at the single SNAP Auction Price. CHX would then process any queued orders or cancels that were not processed earlier in the SNAP Auction process and resume automated trading in the subject security.
A unique aspect of SNAP Auctions is the Auction Only Order (AOO). AOOs would be accepted by CHX starting at 6 AM C.T. each trading day. AOOs would never be placed in the CHX order book for automated trading and, thus, AOOs cannot be matched during automated trading, cannot be “pinged,” and cannot otherwise be detected by any market participant. AOOs will be limit orders or pegged orders (i.e., pegged to the NBB or NBO (with or without an offset) or pegged to the NBBO midpoint) with or without an overriding limit price. Pegged AOOs would be algorithmically priced during the SNAP Auction. AOO time priority would be based on the time the AOO was initially received and, thus, AOOs held by CHX before the start of a SNAP Auction would always have time priority over orders of the same price received after the SNAP Auction begins.
In sum, SNAP Auctions will offer the following benefits to the market:
Reduce Fragmentation: by conducting a Regulation NMS-compliant auction which protects – and thereby draws into the SNAP Auction – the (protected) top of book of any exchange and the FINRA ADF, SNAP Auctions will reduce market fragmentation. It is important to note that while SNAP Auctions cannot protect size below the published away top of book, as such information would not be known to CHX, it is this very fact that could influence order senders to submit orders to participate in the SNAP Auction. Specifically, SNAP Auctions may create a dilemma for order senders with orders resting on away markets at prices below the away markets’ top of book, as such orders may be traded-through by the SNAP execution. As a solution, such away orders (e.g., retail orders placed by a brokerage firm or a wholesaler/market maker) could be canceled on the away market and temporarily moved to CHX to seek protection and/or price improvement in the SNAP Auction. Failure to move such away orders to CHX may expose the brokerage firm or wholesaler to customer service issues, if such away orders were placed on behalf of a customer. Similarly, such away orders placed by institutions, market makers, high frequency trading firms, or others may be traded through and then executed at a price inferior to the SNAP Auction price, which would likely result in profits to SNAP Auction participants at the expense of those who opted not to join the SNAP Auction. Thus, there are numerous financial incentives for market participants to – at least temporarily – consolidate their buying or selling interest at CHX during a SNAP Auction.
Minimize Speed Advantages, Gaming Opportunities, and Information Leakage: the use of AOOs would meaningfully minimize the speed advantages enjoyed by some market participants, by reducing its impact in establishing execution priority within the SNAP Auction Book. Also, randomization of the SNAP Order Acceptance Period and prohibiting order cancelations by order senders during a SNAP Auction would minimize gaming opportunities. Finally, not disclosing material terms of the SNAP Order, conducting the SNAP Auction entirely in the dark, and making AOOs – which are expected to provide a major source of auction liquidity – virtually impossible to detect during automated trading, would all significantly reduce information leakage.
Given its status as a national securities exchange, CHX is required to maintain rules approved by the SEC, pursuant to the Securities Exchange Act of 1934, detailing, among other things, the operation of its trading functionalities, such as the SNAP Auction. The fact that CHX is proposing to provide detailed and comprehensive rules governing SNAP Auctions, the approval of which is subject to public comment and SEC review, is a hallmark of the transparency offered by national securities exchanges, which is in stark contrast to ATSs, none of which are obligated to maintain the same level of transparency. CHX has gone to great lengths to design SNAP Auctions to address the current challenges in today’s marketplace that exist when seeking liquidity to execute a block size transaction. Only time will tell the extent to which CHX has been successful in addressing these challenges. However, SNAP Auctions are certainly a new and innovative approach for locating block size liquidity, which is worthy of consideration by all market participants.
Mr. Givot is Senior Vice President of Strategy and Product Management for Chicago Stock Exchange, Inc. (CHX). From 1979 to 2006, Mr. Givot was an owner and officer of a CHX member firm.
Prior to joining the Exchange, Mr. Givot served on the board of the CBOE and worked for the Harrison Trading Group and the Boston Options Exchange. Mr. Givot earned an M.B.A. with Honors from the Graduate School of Business of the University of Chicago in 1974, an M.Sc. in Management Science with a Mark of Distinction from the London School of Economics in 1973, and an S.B. in Electrical Engineering from the Massachusetts Institute of Technology in 1971.
The SEC Approval of CHX SNAP Auctions can be found here:
The CHX press release on SNAP can be found here: