On the eve of the opening of the U.S. equity market’s newest exchange, Nasdaq has unveiled a new order type.
IEX will officially become an exchange tomorrow, when it begins migrating securities onto its exchange trading system. The phase over of securities will be completed by September. The unique feature of IEX and much debated – especially by Nasdaq – is its 350-microsecond delay, or ‘speed bump’ in order handling. The speed bump is designed to thwart hyper-low latency traders and lure institutional investors and their block trades.
Nasdaq’s Extended Life Order would be given priority over other orders of similar price (but could be immediately cancelled) no matter when the orders were placed. According to Richard Repetto, analyst at Sandler O’Neill, this essentially creates a “price/commitment/time” priority market vs. the current price/time market that most traders have become accustomed to in the U.S.
Nasdaq plans to make the new order type available for use by the end of the year.
“Don’t get confused — speed is still likely to be important,” Repetto told Markets Media. “While the ELO would rest on Nasdaq’s limit book for at least ‘about a second’, still speed traders could theoretically interact with the order only if they are the fastest to the exchange. It could, however, improve the probability of getting filled against the passive limit order since it cannot be cancelled as quickly. We believe here rests the innovation as extended life orders improve the quality of the markets (potential improved fill rates) without necessarily “slowing down” the market (i.e. no speed bumps).”
Repetto then focused on the issue of rebate.
“The level of rebate will be an important question. We believe the amount of rebate that the ELO order type will receive could determine its popularity especially with the sell-side and retail orders,” he noted. “If the rebates are low, we suspect the exchanges who pay high rebates may still be the preferred choice of venue.”
However, if the rebates are near or on par with current levels, the ability to get “priority” or move to the head of the line at that exchange may be compelling, he added.
Currently, Nasdaq has neither determined nor announced the level of rebate on its ELO type.
“This could be compelling for retail folks or their retail brokers,” he continued. “Retail limit orders are unique in that first, the majority are genuinely extended life and not intended to be cancelled within a second) by nature. Second, a large amount are entered “pre-market”. Under these circumstances, we believe retail brokers could be compelled to use extended life orders or risk being pushed back in the queue in a price/commitment/time priority market structure.”
He continued by adding that in Canada this has been the case – especially for less liquid stocks, as brokers default to “long life orders” to give their retail orders priority (and as rebates have been maintained at their current levels).
According to Repetto’s research, Canada TSX reports LLO results and he uncovered the following:
– The percentage of Long Life Order (LLO that have a similar 1 second minimum life) executed trades on the passive side were approximately (1) 30% for ETFs, (2) 45% for inter-listed stocks, (3) 70% non inter-listed stocks, and (4) 80% for TSV stocks.
– Thus, a higher percentage of LLO trades occurred in less liquid, low turnover stock/security subsets, which in his view have less HFT activity.
“But to be clear, HFT can also participate in LLOs provided they adjust their quotes for the added risk of being on the books for a full second (and their inability to immediately or in microseconds cancel quotes),” he said.
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