NYSE-ARCA Merger

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The NYSE Hybrid MarketSM plan expands
execution choices. Investors and traders
will be able to choose from the speed and
certainty of an automatic execution or the
opportunity for price improvement from the
auction market. Automatic trading is a
dramatic change for the NYSE: Ever since
the first trade took place in 1792 under
the Buttonwood Tree, the NYSE has
operated an auction market. The NYSE
Hybrid plan and Regulation NMS will
enable the listed market to trade with the
efficiency of OTC-stocks. In our three-part
series, we will look at the Hybrid proposal.
This month we will examine Hybrid basics
— how the proposal changes the current
market for liquidity takers. In subsequent
issues of Equity Research & Strategy, we
will look at the roles of the specialist and
the floor broker and work through
examples of how orders will be handled in
the new NYSE structure.
Hybrid — The Fast Market
The NYSE Hybrid MarketSM proposal is still
pending approval by the Securities and
Exchange Commission (SEC). Assuming
regulatory clearance, the exchange will
introduce the Hybrid market in phases with
the final rollout occurring in the Spring of
2006. This phased rollout, according to
exchange officials, will provide the
specialist, floor and market participants
the opportunity to slowly get used to the
new execution priority and the new ways
to interact in the marketplace. NYSE
Hybrid fundamentally changes how the
NYSE will operate for liquidity takers. In the
auction market, the specialist was
primarily the catalyst for trading. The floor
could participate or go along with any
execution. In the new Hybrid trading rules,
the auto-execution order has priority, giving
market participants greater execution
speed and certainty.
New Order Types
Three new order types are being introduced
— an auto-ex order type, and Auction Limit
(AL) and Auction Market orders. AL orders
enable investors to send orders to the
specialist in order to seek potential price
improvement from the auction market.We
will discuss the AL order type in more
detail next month when we focus on the
role of the specialist.
AUTO-EXECUTION
From the time the exchange officially
disseminates a price until 3:59:00 P.M., all
NYSE Hybrid market quotes will be subject
to automatic execution unless designated
otherwise (see Liquidity Replenishment
Point below). To achieve an auto-execution
market, the exchange is expanding NYSE
Direct+®. The NYSE is eliminating the size
restrictions (1,099 shares for stocks and
10,000 shares for Exchange Traded Funds
[ETFs]) and the current 30-second
limitation for consecutive orders. They are
also creating a new “Immediate-or-Cancel”
(IOC) order type and will permit auto-ex
market and auto-ex marketable limit orders
to “sweep” the NYSE Display Book®.
Sweeps
NYSE sweeps operate differently than in
the OTC market. In the OTC market,
investors are filled at each price level. In
an NYSE sweep, if the sweep extends
beyond the BBO, a “clean-up” is
determined and intervening posted
liquidity is afforded price improvement.
Let’s look at some examples.
In the case of a buy, the order will execute
at the offer price for the published volume.
The Regulation NMS order-protection rule
protects top-of-file quotations in the
national market. The NYSE will sweep
price-level by price-level and in
accordance with Regulation NMS. The
NYSE will then send orders to other market
venues whose top-of-file quotation (not
 
the depth of book) are in the sweep
(Figure 1). The NYSE will seek to
internalize as much of the order as
possible. Although the sweep will respect
the order-protection rule for the top of
file, it will not send orders to better-priced
liquidity that is in the depth of book of
another market venue. The SEC still must
determine if the specialist can decide to
add liquidity and match other “protected”
market venue quotations to avoid routing.
Sweep orders will execute to a price level
that is either the order’s limit price, fills
the order or reaches a Liquidity
Replenishment Point (LRP).
Clean-up Price
All sweeps beyond the BBO will have two
execution prints — the liquidity that was at
the published BBO and then a “clean-up”
price. The “clean-up” price is the price level
that completed the order. It could be either
the order’s limit price, the level that
completed the order or a Liquidity
Replenishment Point. Resting bids and
offers in the NYSE Display Book® between
the displayed BBO and the price at which
the sweep ended (the clean-up price)
receive price improvement. For example,
(Figure 2), a sweep from $23.96 to
$23.99 will have two prints — the stock at
$23.96 and the clean-up price at $23.99.
Any resting orders at $23.97 and $23.98
will receive price improvement and be
printed at $23.99.
Liquidity Replenishment Point (LRP) —
Temporary Suspensions in Auto-Execution
The NYSE believes that a pure autoexecution
market introduces undesirable
volatility. Rather than allowing prices to
gyrate at times of market stress or order
imbalances, the exchange has created LRP
“circuit-breakers.” LRPs are volatility
moderators that suspend auto-execution
and provide the specialist, crowd and
market participants the opportunity to
enter orders and replenish liquidity on
either side of the market. Two LRPs are
proposed — a Price-based LRP (P-LRP)
and a Momentum-based LRP (M-LRP).
The P-LRP is a minimum of five cents from
the exchange bid or offer rounded to
the nearest nickel. For example, if the
market is $20.10 - $20.12, the P-LRP
is at $20.05 - $20.20. If the market is
$20.04 - $20.09, the P-LRP would be
$19.95 - $20.15.
The M-LRP may be triggered if electronic
trading results in rapid price movement
over a short period of time. If a security
has moved the greater of 25 cents or
1 percent of its price within 30 seconds,
automatic trading is suspended. An
M-LRP in an $18.00 stock would be 25
cents. The M-LRP in a security priced at
26.49 would be rounded down to 26
cents. The benchmark price of the M-LRP
is determined by the high/low trades that
occur in the prior 30 seconds.
Hitting an LRP and the Resumption of
Auto-Execution
If the auto-ex market or marketable
limit sweep order is sent tagged as an
IOC order, and it hits an LRP and isn’t
completed (has a residual balance), then
the remaining balance is immediately
cancelled. Whenever an LRP is reached,
auto-execution is suspended and the NYSE
becomes a slow market venue. NYSE
quotes at this time will be protected under
Regulation NMS.
During this time, when the NYSE suspends
auto-execution, incoming orders and
cancellations will continue to be reflected
automatically in the book. When does
auto-execution resume? It depends upon
how the LRP was hit. If the order that
caused the LRP to be hit is filled in its
entirety or the remaining balance has been
cancelled because it was an IOC sweep,
then automatic executions and auto-quote
will resume no more than five seconds
from when the LRP was hit. It can resume
earlier than five seconds if the specialist
manually intervenes and either trades or
re-quotes the market.
What happens when a non-IOC sweep
order hits an LRP and has a residual
balance? The residual balance at the
LRP will be represented in the auction
market. It will be represented so that it
does not lock or cross the national market
quote. Automatic execution is suspended
and is required to resume in no more than
10 seconds. It is expected that the
specialist will quote or trade before the
10-second limit has lapsed, unless an
imbalance exists or a trade is being put
together by the floor. The crowd has 10
seconds to complete the trade before
auto-ex resumes.
The NYSE is seeking to create an
integrated auto-ex/auction market. This
new NYSE market structure will deliver the
speed and immediacy that traders now
experience in the OTC market. In the first
of this three-part series, we looked at the
basics of Hybrid auto-execution. Next
month, in the second part, we will
examine the role of the specialist and the
floor broker, and how they will interact with
the auto-ex and auction market orders in
the Hybrid world. ■
 
Less than 10 percent of volume in
exchange-traded funds (ETFs) occurs in
auction market venues. In fact, in the
150 most active (by volume) NYSElisted
securities (from March 27 to July
7) 20 percent or more of volume was
executed via FAST electronic market
venues — through the BLOOMBERG
TRADEBOOK®, market makers and other
ECNs in the NASDAQ
Market CenterSM, and
auto-ex venues like
Archipelago Exchange.
The electronic market
venues are also a
significant source of
liquidity during times of
stress — for example,
when breaking news
affects a stock. The
challenges to executing
NYSE-listed stocks are
well documented.
Although NYSE Hybrid
and Regulation NMS will
improve the market
structure, they are
scheduled to roll out in
the Spring of 2006 —
nine months! When
speed, immediacy and
certainty of execution are
at a premium, traders may elect to
avoid slow markets and trade only with
the fast markets. BLOOMBERG
TRADEBOOK®’s Order Handling Facility
AUTO-EX order type can provide traders
with this level of flexibility.
The AUTO-EX order type responds only
to fast market quotes. It respects the
trade-through rule. Passive limit orders
are posted in CQS (via NASDAQ Market
CenterSM), which affords them
Intermarket Trading System (ITS) tradethrough
protection. The auto-ex order
will not respond (send orders) to slow
market centers. Rather, it will stand its
ground if a slow market locks, and
leverage our OTC-style Anti-Lock Breaks
so that quotes will not lock or cross the
national market. By standing its ground,
slow market venues respond to your
quote as a firm electronic ITS
commitment to trade. This order type
can provide a powerful new dimension
to trading NYSE-listed stocks. Let’s look
at some strategies.
Trading ETFs
Speed, immediacy and certainty are
critical to ETF traders. It is, in part, one
reason that ETF trading is dominated by
the fast market venues. In fact, most
traders find manual exchanges to be
inconvenient intermediaries in an
increasingly efficient marketplace. Since
liquidity at a price level in these
securities is typically not an issue, most
traders would simply avoid manual
execution venues. For ETFs, the AUTO-EX
order type enables traders to trade only
with the fast markets and not have their
orders unnecessarily delayed by the
slow venues (Figure 1).
Splitting Orders between the NYSE
and Auto-Ex
Direct participation with liquidity on the
floor of the NYSE, at times, can be
critical to an efficient execution. In
second-tier liquid stocks, although some
liquidity may be in the third market or
on the ECNs, traders still have to have
access to the crowd because floor
brokers may be actively assembling
trades. If the order is somewhat
sizeable, most traders would be
reluctant to send it down to the NYSE
via DOT (NYSE SuperDotSM) for fear of
specialist intermediation and the
potential for information leakage. Yet at
the same time, by not participating in
the trading on the ECNs, third market
and electronic exchanges could adversely
impact the order’s average price. More
and more traders are electing to use
a “split order” approach. BLOOMBERG
TRADEBOOK® enables traders to split
their order — by electronically sending
a portion of the order to the floor using
 
our network of independent floor
brokers (Figure 2) and working the
remaining quantity using the AUTO-EX
order type. The floor order gives traders
representation on the NYSE while the
auto-ex order trades with the
fragmented liquidity in the fast market
venues. Since the auto-ex order type
avoids the NYSE there will be no
duplication of efforts.
Setting up Strategic Orders
Traders can set up several AUTO-EX
strategies using BLOOMBERG
TRADEBOOK® Strategic Orders
(BTSV <Go>). The first step is typing
BTSV <Go>, and clicking on the
“Listed Saved Orders” tab at the top of
the screen. From here the trader can
select the side, quantity, appropriate
strike price and then select AUTO-EX
from the Bang/Destination field.
Alternatively, traders can select from
several AUTO-EX orders in the
BLOOMBERG TRADEBOOK® library of
strategic orders. For example, traders
can select/create multiple strategies
for various volume levels on either side
of the market. For instance, buy orders
for 10,000, 25,000 and 50,000 shares
that only send orders to execution with
the AUTO-EX venues. Once the strategy
is saved and named it will appear
alongside other strategy buttons on
the BMQ <Go> single security monitor
(Figure 3). Traders will typically create
multiple strategies for various volume
levels on either side of the market, for
example 10,000, 25,000 and 50,000
shares. Depending on the strategy of
the trader, hitting bids and lifting
offerings may be appropriate, or a
specific limit price may be more
desirable. Clicking on the strategy
button on the BMQ screen will bring
up the ticket, already populated with
the appropriate order criteria.
The growing percentage of liquidity
trading away from the primary
exchanges combined with a trader’s
desire for immediacy and minimal
intervention makes the auto-ex order
type a requirement for the active listed
trader. Traders want and need to be able
to execute quickly against available
liquidity rather than wait for a specialist
to fill orders. The extent of automation at
the NYSE following the introduction of
the Hybrid model is uncertain. Traders
need the flexibility of the OHF and autoex
order type to work their orders where
they feel they are able to seek the best
execution for their particular strategy.
 
In last month’s Equity Research & Strategy,
we focused on the liquidity taker — how an
electronic auto-execution order would
interact with the NYSE Hybrid Market.SM We
explained how a “multi-price-level sweep”
would be awarded two prices — the best
bid/offer (BBO) and a “clean-up” price.
Beyond the BBO, all executions would be
cleaned-up — awarded the price level at
which the sweep stopped. In auction market
terms, this would be similar to the NYSE
conducting mini-Dutch auctions for multiprice-
level sweeps. The clean-up price
provides price improvement to resting limit
orders involved in a sweep — and can serve
as an incentive for investors to add depth to
the NYSE market. In this month’s issue, we
focus on what actually happens to orders on
the NYSE book. How does the NYSE
matching algorithm actually work? It is very
different from the traditional strict time/price
priority in OTC market venues (ECNs, ATSs,
electronic exchanges, etc.) and the trading
rules on the global electronic exchanges’
matching engines. Hybrid follows Priority, Parity
and Precedence.
There are three constituent groups in the
NYSE market — the public NYSE Display
Book®, the floor broker and the specialist’s
dealer account.We are going to focus on the
role of the specialist in next month’s Equity
Research & Strategy.
The Role of the Floor Broker
The NYSE Hybrid MarketSM is designed so
that floor brokers can continue to represent
their customers in the auction market as they
do today — work-up trades and negotiate
prices without being required to disclose
their intentions to other participants. They
can use their judgment and represent/work
large orders on behalf of their clients both
electronically and in person and on the
trading floor.
Floor brokers can represent orders in the
electronic market (making them available to
auto-execution sweeps, etc.) via a “Broker
Interest File.” The interest file is an electronic
placeholder. Because the brokers tend to
represent large orders, the NYSE has
provided them with “Reserve” functionality. To
use Reserve, the floor broker has to display a
minimum of 1,000 shares. For example, if
the broker is working a 25,000-share order,
he has to display a minimum of 1,000
shares and the balance (24,000 shares) can
be undisplayed in Reserve. The broker can
have “interest” (with a Reserve component)
at varying price levels. Additionally, the floor
broker’s display interest will not be publicly
disseminated to the public unless it is at the
BBO. The floor broker is only permitted to
have interest in only one crowd (or station
position) at a time. The NYSE will be
reconfiguring the trading posts to
accommodate five stocks.
Priority, Parity, Precedence
The controversy of Hybrid stems the
application of Priority, Parity and Precedence
(Rule 72 in Amendment 5 — Federal
Register, June 29, 2005). To understand how
this execution hierarchy operates, let’s work
through an example (Figure 1).
Let’s assume that the market is 99.27-28,
1,000 x 1,000. Let’s assume that you are
the first bid at 99.26 for 1,100 shares. A few
seconds later, another public order arrives for
500 shares. Floor broker A places broker
interest for 1,000 shares (with 10,000
shares in Reserve) and then floor broker B
places interest at 99.26 for 1,000 shares
(with 49,000 shares in Reserve). The publicly
 
disseminated display book at 99.26 is
1,600 because the floor broker interest is
only disseminated when it is at the BBO.
Now, the 99.27 bids get hit and the market
is 99.26-28. All of the broker interest is now
disseminated and the market is 99.26-28,
3,600 x 1,000.
Priority — The first bid has priority for the
first incoming order.
The priority in the execution queue is for
display — Reserve is at the end (Figure 2 —
Part 1). Let’s assume that two auto-execution
orders arrive within a millisecond of each
other to hit the 99.26 bid. The first incoming
order is for 100 shares and the second one
for 3,000 shares. Being first at the level gives
you priority for the first order that comes in —
in this case the 100 shares — but your order
will not be completed with the second
incoming order of 3,000 shares. After the
100-share trade “clears the floor” (the
NYSE’s terminology for when the trade is
matched), the book flips to parity in order to
get ready for the “next auction” for the next
incoming order.
Parity — The auction market takes over —
all orders at the price level “Go-Along” and
share in subsequent executions.
The book (Figure 2 — Part 2) takes on a
different form. The public book (your
remaining 1,000 shares and the 500 shares
that arrived after your order) are represented
together and each broker interest joins in
parity. So when the 3,000-share order
arrives, it gets shared. The public book gets
1,000 shares and the two broker interests
each get 1,000 shares (Figure 2 — Part 3).
In the public book, you and the other bidder
at 99.26 each RECEIVE 500 shares. You
remain on the bid for 500 shares. Note, all
disclosed interest trades before Reserve. So
if the incoming order was larger than 3,000
shares, only the 1,000 shares per broker
would be on parity — broker Reserve would
trade only after your order was completed.
Let’s assume that the incoming order is only
2,500 shares. Again, the market is on parity
so the trade gets split three ways — the
public book getting 834 shares (with your
order and the other public order receiving
417 shares each) and the two broker
interests getting 833 shares each. If the
market goes to 99.27 bid again, the display
at 99.26 level remains on parity — so if the
market goes back to 99.26 bid, the three
books will share the incoming order. If
another order arrives at 99.26, it will be
placed in execution priority ahead of the
broker Reserve at the level, but behind the
displayed orders that are on “parity.”
The Global Exchanges
In contrast to Priority and Parity, the global
electronic exchanges would execute in
time/price priority. The first order of 100
shares would execute with your order. The
second order of 3,000 shares — 1,000
would execute with your order, 500 toward
the second public order, then 1,000 would
go to the floor broker A and 500 to the floor
broker B.
Precedence — Provisions for size
Rule 72 discusses a concept called
“precedence based on size.” This means that
a bid or offer that can trade with the entire
size of an incoming order may supersede
lesser-sized orders. In today’s auction market,
this practice is rarely employed — as the
specialist typically enables floor brokers at
the same level to Go-Along with the trade so
they don’t miss out on prints. It’s not clear
how this provision would be implemented in
the Hybrid-matching algorithm.
Hybrid’s matching algorithm will be unique
among markets that offer electronic access.
Global exchanges, ECNs, ATSs and other
electronic exchanges typically employ
time/price priority when matching orders. The
NYSE believes that the auction market adds
value to the execution process and has
designed a system to replicate electronically
what happens generally in the auction
market today. Priority, Parity and Precedence
enable orders to share in execution prints,
much like the auction process. NYSE Hybrid
introduces more execution choices. Regulation
NMS creates a level playing field for market
venues to compete. Thus, investors will be
able to choose if time/price or Priority, Parity
and Precedence is best for their order.
 
I read the actual pdf version (much easier to read) and have a couple thoughts.

Isnt order parity totally unfair? Does any other market operate not on a first come first serve time based priority? So what if the first order is priority filled, what if its 100 shares and the next fill is 5000 shares? I really dont understand how its fair that i get in line after everyone else has been waiting and split the fill with people. Also, I was under the impression orders represented on the book get filled before floor brokers not displaying on the open book, so now i have to split fills with them? Again, i need help with this logic.

Second, the clean up price on large sweeps also seems ridiculas. If i list on the offer to go short, for instance, and a large market order comes in and needs to take out the next 4 price levels to fill, i would be filled at the inside price while the people offered 1 and 2 cents higher get price improved to the 3rd cent, while im offside 3 cents instantly? Why is that fair. There would be more incentive for me to list a cent higher and never be at the inside price for opening long/short positions because i would constantly be offside a few cents by some big order not improving me.

Any help on why they decided on these features would be helpful.
 
Quote from Szeven:

Isnt order parity totally unfair? Does any other market operate not on a first come first serve time based priority? So what if the first order is priority filled, what if its 100 shares and the next fill is 5000 shares? I really dont understand how its fair that i get in line after everyone else has been waiting and split the fill with people. Also, I was under the impression orders represented on the book get filled before floor brokers not displaying on the open book, so now i have to split fills with them? Again, i need help with this logic.

Second, the clean up price on large sweeps also seems ridiculas. If i list on the offer to go short, for instance, and a large market order comes in and needs to take out the next 4 price levels to fill, i would be filled at the inside price while the people offered 1 and 2 cents higher get price improved to the 3rd cent, while im offside 3 cents instantly? Why is that fair. There would be more incentive for me to list a cent higher and never be at the inside price for opening long/short positions because i would constantly be offside a few cents by some big order not improving me.

Any help on why they decided on these features would be helpful.
More...

It is unfair and that is the point. I read these concerns in a few articles a while ago and it's quite interesting. With these new BS rules, the NYSE can preserve & protect their racket while at the same time throw the traders & programs against each other in the fast electronic market. Whenever needed, the specialist will step in and the good ole boys will execute what they need, steal their cut and then let the electronic market with pennying fighting continue.
The floor get priority on fills when it goes into auction mode and separate the electronic orders from the floor orders unlike it is now where the book gets priority based on time and price (except block prints).
And the game continues.
 
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