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Wall Street split over stock exchange's 4-millisecond trading 'speed bump'

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Wall Street's fastest traders rely on towers such as this one in Aurora, Ill., to send trades via microwave connections between the Chicago area and other data centers around the world.

Source: Declan Harty, S&P Global Market Intelligence

Wall Street is divided over the latest plan to put speedy traders on notice.

Three years ago, IEX Group Inc. ignited a debate across the U.S. stock market when it proposed to launch a national securities exchange that featured a 350-microsecond delay known as a speed bump. The mechanism was designed to level the playing field between slow-moving market participants and faster traders who use sophisticated algorithms and technologies to move in and out of their positions at breakneck speeds.

After the venture was approved following a lengthy and contentious review, other exchange operators, including the Intercontinental Exchange Inc.-owned New York Stock Exchange and Nasdaq Inc., introduced similar delays. Now, Cboe Global Markets Inc. is looking to become the latest exchange giant to jump in on the speed-bump craze, having filed a proposal with the SEC in June.

But the third-largest U.S. stock exchange operator is diverging from its peers with a planned speed bump that has reignited the debate up and down Wall Street over how far such delays should be allowed to go.

The Chicago-based bourse would install a speed bump on its EDGA Equities Exchange, the smallest of its four venues, that would be more than 10x longer than IEX's and would leave liquidity-providing orders untouched, both of which are key differences from the existing stock market delays.

With its proposal, Cboe hopes to grant some relief to market makers from Wall Street's fastest traders, who use high-speed microwave connections between suburban Chicago and New Jersey to trade stocks on the latest information before market makers can adjust their bids and offers. At 4 milliseconds long, the speed bump would provide those slower market makers, which continually provide bids and offers throughout the trading day, a window of time to reprice their orders accurately before faster traders can execute their trades at a soon-to-be stale price. Market makers XTX Markets LLC and CTC LLC said in comment letters that Cboe's proposal would allow them to provide more robust liquidity on EDGA and better prices to the rest of the market.

"If there's a very fast firm out there that can pick off the market maker, they're going to do so," said Parker Lim, head of equities strategy at Cboe, in an interview. "They can't keep up with the arms race for faster and faster technology."

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But the rest of Wall Street is not quite so sure about Cboe's proposal, as critics say investors could suffer from worse execution prices if market makers are allowed to bypass the delay.

"While asymmetric speed bumps are falsely advertised as protecting investors, the only real beneficiaries are a select group of traders who are not just able to — but are actively seeking to — exploit the functionality," wrote Stephen Berger, Citadel Securities LLC's global head of government and regulatory policy, in a July 17 comment letter.

One of Wall Street's biggest and fastest traders, Citadel cited an example in its letter where a large institutional order is routed to several exchanges at the same time. When the order hits EDGA, it would have to then go through the 4-millisecond delay. Citadel said that fraction of a second would be enough time for the market maker's algorithms to see the trading activity on other exchanges and adjust the EDGA offer to reflect the increased demand.

That could ultimately leave institutional investors such as T. Rowe Price Group Inc. with worse execution prices. The Baltimore-based asset manager, which has $1.125 trillion under management, also opposes Cboe's plan, saying that investors could be hit with a "paint can" of worse prices as a result of the market maker getting out of the way when a trade is no longer favorable for them. If Cboe's proposal is approved, Mehmet Kinak, T. Rowe's global head of systematic trading and market structure, said he would likely encourage his brokers to not route their trades to EDGA.

"They're going to be there much more often. But not necessarily with the intent to trade, only with the intent to trade when it's beneficial to them," Kinak said in an interview. "I don't need to play that game."

T. Rowe would be able to do so because EDGA quotes would be unprotected under Cboe's plan, meaning brokers would not be forced to route their clients' orders to EDGA as they would for other exchanges under the SEC regulation known as the Order Protection Rule. The mandate legally prohibits brokers from executing a client's order at a price that is worse than what is available on a U.S. stock exchange.

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Dallas-based CyrusOne operates data centers around the Chicagoland area, including this one in Aurora, Ill., which is a core computing home for CME Group's markets.

Source: Declan Harty, S&P Global Market Intelligence

Whether U.S. regulators are open to an asymmetric speed bump is unclear. Chicago Stock Exchange Inc., now called NYSE Chicago under its new owner ICE, introduced a proposal to implement one in 2016. But the exchange withdrew after the SEC's commissioners froze an earlier approval from the regulator's staff.

By making EDGA quotes unprotected, Cboe may be looking to address reported concerns among the SEC's commissioners about giving a platform with an asymmetric speed bump the same status as other exchanges.

The SEC has said that stock-trading delays would not impair fair and efficient access to a quotation if they are shorter than 1 millisecond, according to 2016 guidance issued by the staff. With its speed bump lasting 4x longer than the SEC's "de minimis" threshold, the exchange opted to make the EDGA quotes unprotected, Cboe's Lim said. While that would mean that EDGA would not be guaranteed any order flow, Lim said brokers will still route to the venue because he believes the speed bump will lead to narrower spreads and more robust trading activity, not phantom liquidity.

"We wouldn't be doing this if we thought that that was the case," Lim said. "If this is going to be a success in the way we think, in that it protects liquidity providers, then we should be able to implement the asymmetric speed bump as is."