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SEC rejects Cboe's controversial 4-millisecond trading speed bump

SNL Image
A trader works in the Chicago pits of Cboe Global Markets in 2017.
Source: S&P Global Market Intelligence

Wall Street's top regulator has rejected a hotly contested plan from Cboe Global Markets Inc. to introduce a new type of speed bump in the U.S. stock market.

The U.S. Securities and Exchange Commission filed its ruling Feb. 21 after a handful of delays and an industrywide debate over the Chicago-based market operator's proposal to introduce a 4-millisecond trading delay on its EDGA Equities Exchange. The decision comes as a win for much of Wall Street — several big-name asset managers and broker/dealers had staunchly objected to Cboe's plan.

"The Commission concludes that the proposal is discriminatory and the Exchange has not demonstrated that the proposal would not be unfair," the SEC wrote in its decision.

In a statement, Cboe said it is "extremely disappointed" in the SEC decision.

"Cboe will remain committed to enhancing the U.S. equity markets for all participants, and will continue to work closely with our regulators and industry to develop innovative products that benefit the marketplace," the exchange added.

The ruling follows several years of trading venues across asset classes introducing speed bumps as a way of protecting certain investors. IEX Group Inc. helped introduce the model in the U.S. market after it was approved in 2016 to launch a stock exchange that included a 350-microsecond delay.

IEX's pioneering speed bump was designed to level the playing field between slower-moving institutional investors and Wall Street traders who use algorithms and technology to move in and out of their positions at lightning-fast speeds. The exchange's approval set off a chain reaction, with Intercontinental Exchange Inc.'s New York Stock Exchange and Nasdaq Inc. soon rolling out delay mechanisms of their own that closely resembled IEX's. NYSE has since eliminated its speed bump because of deteriorated market quality and liquidity, the exchange said in 2019.

Cboe foresaw a different path for its speed bump, though.

Lasting 4 milliseconds, Cboe's speed bump would have been more than 10x longer than IEX's and allowed liquidity-providing orders to skip over the delay. The so-called asymmetric speed bump was designed to provide market makers with a brief window of time where they could reprice their orders before faster traders who use microwave connections between suburban Chicago and New Jersey were able to executive their own orders at those soon-to-be stale prices, Cboe said.

"The risk introduced by microsecond-level pick-offs, and the corresponding cost of the never-ending arms race for speed, has resulted in less-attractive pricing and inferior displayed liquidity on many markets and in many asset classes," wrote Steve Crutchfield, CTC LLC's head of market structure, in an Oct. 28, 2019, comment letter that was in favor of the proposal. "Asymmetric speed bumps are an efficient way to mitigate this risk and once again encourage competition to display liquidity."

Yet, the proposal incited an uproar on parts of Wall Street.

Citadel Securities LLC, BlackRock Inc. and T. Rowe Price Group Inc., among others, opposed Cboe's speed bump through various comment letters to the SEC after the exchange filed its proposal in June 2019.

At the heart of their concerns was a fear that Cboe's proposed speed bump would unnecessarily increase the complexity of trading in the U.S. equity markets and would risk creating worse execution prices for both retail and institutional investors. Baltimore-based T. Rowe Price notably said the proposal would allow market makers to ditch trades when they are no longer favorable to them, leaving investors with worse prices.

The SEC ultimately sided in favor of those critics, ruling that Cboe had not made a clear enough case to justify the EDGA delay.

Among several issues the SEC had with Cboe's proposal, the agency said the exchange did not provide enough evidence that its speed bump would "not permit unfair discrimination" against liquidity-taking orders that are not related to high-speed trading tactics.

"The Exchange has not demonstrated that the proposal is sufficiently tailored to its stated purpose, which is to improve displayed liquidity on the Exchange by reducing the risk of adverse selection to liquidity providers," the regulator said.