[Federal Register Volume 78, Number 211 (Thursday, October 31, 2013)]
[Notices]
[Pages 65396-65400]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-25829]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-70756; File No. SR-BX-2013-016]
Self-Regulatory Organizations; NASDAQ OMX BX Inc.; Order
Disapproving Proposed Rule Change To Adopt a Directed Order Process
October 25, 2013.
I. Introduction
On February 21, 2013, NASDAQ OMX BX Inc. (``Exchange'' or ``BX'')
filed with the Securities and Exchange Commission (``Commission''),
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to
establish a directed order process for the trading of listed options.
The proposed rule change was published for comment in the Federal
Register on March 11, 2013.\3\ The Commission received a comment letter
on the proposal,\4\ BX's response to the comment letter,\5\ and a
follow up comment letter from the same commenter.\6\ On April 17, 2013,
BX filed Amendment No. 1 to the proposed rule change.\7\ On April 22,
2013, BX extended to June 6, 2013 the time period within which the
Commission must approve the proposed rule change, disapprove the
proposed rule change, or institute proceedings to determine whether to
disapprove the proposed rule change. On June 3, 2013, the Commission
instituted proceedings to determine whether to approve or disapprove
the proposed rule change.\8\ The Commission received a letter from BX
responding to the Order Instituting Proceedings,\9\ another comment
letter from the same commenter--NYSE Euronext--who had commented
previously on the proposed rule change,\10\ and a follow up letter from
BX in response to NYSE Euronext's comment letter.\11\ This order
disapproves the proposed rule change.
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\1\ 15 U.S.C. 78a.
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 69040 (March 5,
2013), 78 FR 15385 (``Notice'').
\4\ See Letter, dated April 2, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Janet McGuiness, Executive Vice
President, Secretary and General Counsel, NYSE Euronext (``NYSE
Euronext Letter 1''). For a summary of this letter, see Securities
Exchange Act Release No. 69684 (June 3, 2013), 78 FR 34683 (June 10,
2013) (``Order Instituting Proceedings'').
\5\ See Letter, dated April 17, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Edith Hallahan, Principal Associate
General Counsel, BX (``BX Letter 1''). For a summary of this letter,
see Order Instituting Proceedings, supra note 4, 78 FR at 34685.
\6\ See Letter, dated May 10, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Janet McGuiness, Executive Vice
President, Secretary and General Counsel, NYSE Euronext (``NYSE
Euronext Letter 2''). For a summary of this letter, see Order
Instituting Proceedings, supra note 4, 78 FR at 34685.
\7\ Amendment No. 1, which the Commission believes is technical
in nature and not subject to notice and comment, clarifies that,
when a Directed Order (as defined below) is submitted in an options
class that is subject to the price/time priority on BX, the Directed
Market Maker's Directed Allocation (as defined below) would be
capped at 40%, unless the Directed Market Maker's size at the first
position in time priority at that price exceeds 40%, in which case
the Directed Market Maker would have priority for that size.
\8\ See Order Instituting Proceedings, supra note 4.
\9\ See Letter, dated July 1, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Edith Hallahan, Principal Associate
General Counsel, BX (``BX Letter 2'').
\10\ See Letter, dated July 15, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Janet McGuiness, Executive Vice
President, Secretary and General Counsel, NYSE Euronext (``NYSE
Euronext Letter 3'').
\11\ See Letter, dated August 28, 2013, to Elizabeth M. Murphy,
Secretary, Commission, from Edith Hallahan, Principal Associate
General Counsel, BX (``BX Letter 3'').
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II. Description of the Proposal
BX proposes to establish a directed order process that would permit
members of BX (``BX Participants'') to direct orders in listed options
(``Directed Orders'') to a particular market maker on BX (``Directed
Market Maker'').\12\ As detailed below, a Directed Market Maker would
be eligible to receive an allocated percentage of the Directed Order
(40%) at all price levels at which the Directed Market Maker has a
quote or order (a ``Directed Allocation'').\13\ To receive a Directed
Allocation, the Directed Market Maker would be required to have quotes
or orders at the National Best Bid or National Best Offer (``NBBO'') at
the time of the execution of the Directed Order; the Directed Market
Maker would not be required to be quoting at the NBBO at the time the
Directed Order is received.\14\ If a Directed Order is not executed
upon receipt, it would be
[[Page 65397]]
placed on the BX book and would retain its status as a Directed
Order.\15\
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\12\ Specifically, BX proposes to add BX Chapter VI, Section
1(e)(1) to Chapter VI to define a Directed Order as ``an order to
buy or sell which has been directed (pursuant to BX's instructions
on how to direct an order) to a particular Market Maker (``Directed
Market Maker'') after the opening.'' BX also proposes to amend BX
Chapter VI, Section 6(a)(2) to include Directed Order to the list of
orders handled within the BX System.
\13\ Proposed BX Chapter VI, Section 10(3)(iv)(C).
\14\ For example, as shown in Example 4 in the Notice, if BX was
not at the National Best Offer (``NBO'') and the Directed Market
Maker was quoting one tick away from the NBO at the time a Directed
Order was received, once the NBO was exhausted and BX became the new
NBO, the Directed Order could be executed at this new NBO and the
Directed Market Maker would receive its Directed Allocation, even
though the Directed Market Maker was not at the NBO at when the
order was received.
\15\ Proposed BX Chapter VI, Section 10(3)(iv)(C). For example,
if a marketable non-routable Directed Order to buy is received on BX
and BX is not quoting at the NBO, the order could not be executed on
BX and could not route. See BX Chapter VI, Section 7(b)(3)(C)
(providing that ``[a]n order will not be executed at a price that
trades through another market. . . .''). Thus, under BX's rules, the
order would be posted on the BX book at the current NBB but
displayed one minimum price increment below the NBO. See BX Chapter
VI, Section 7(b)(3)(C). If the market moves such that the BX best
offer is now the NBO, the Directed Order would be executed against
the BX best offer, which is now the NBO, and the Directed Market
Maker would receive a Directed Allocation of 40% of the Directed
Order. See Notice, supra note 3, at 15390.
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The calculation of a Directed Market Maker's Directed Allocation
would depend on whether the Directed Order is submitted in an options
class that is subject to price/time priority or in an options class
that is subject to the size pro-rata execution algorithm on BX.
Specifically, if an option is subject to price/time priority, a
Directed Market Maker who has time priority at a particular price would
receive the amount of the Directed Order equal to the Directed Market
Maker's quotes/orders with time priority at that price. However, if the
Directed Market Maker does not have time priority for a size equal to
or greater than 40% of the Directed Allocation, the Directed Market
Maker would receive a Directed Allocation of 40% of the Directed Order
at a particular price.\16\
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\16\ Proposed BX Chapter VI, Section 10(3)(i)(A). See also
Amendment No. 1, supra note 7.
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If a Directed Order is submitted in an options class that is
subject to the size pro-rata execution algorithm, any public customer
limit orders resting on the limit order book at the execution price
would first be executed against the Directed Order.\17\ Once all public
customer limit orders are executed, the Directed Market Maker would
receive the greater of: (1) The pro-rata allocation to which such
Directed Market Maker would be entitled or (2) 40% of the original size
of the Directed Order at that particular price. Once the Directed
Allocation is determined, BX proposes to allocate all remaining
contracts of the Directed Order on a size pro-rata basis among all
remaining participants (except for the Directed Market Maker).
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\17\ Proposed BX Chapter VI, Section 10(3)(i)(B).
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If the calculation of the 40% Directed Allocation results in a
fractional remainder, BX proposes to round up the Directed Market
Maker's Directed Allocation to the next whole number whether the
Directed Order is submitted in an options class subject to price/time
priority or in an options class that is subject to the size pro-rata
execution algorithm.\18\ In addition, the Directed Market Maker would
not be entitled to receive a number of contracts that is greater than
the size associated with its quote or order at a particular price.\19\
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\18\ Proposed BX Chapter VI, Section 10(3)(iv)(B).
\19\ Proposed BX Chapter VI, Section 10(3)(iv)(A).
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BX also proposes to reduce the quoting obligations applicable to
its Market Makers that are not Directed Market Makers. Currently, BX
Market Makers are required to quote during regular market hours on a
continuous basis (i.e., 90% of the trading day) in at least 60% of the
series in options in which the Market Maker is registered. The proposed
rule would reduce this requirement such that Market Makers would be
required to quote 60% of the trading day (as a percentage of the total
number of minutes in such trading day) or such higher percentage as BX
may announce in advance, in all options in which the Market Maker is
registered.
The quoting obligations applicable to Directed Market Makers would
be higher than those applicable to Market Makers that are not Directed
Market Makers. Specifically, Directed Market Makers would be required
to quote such options 90% of the trading day (as a percentage of the
total number of minutes in such trading day) or such higher percentage
as BX announces in advance, applied collectively to all series in all
of the option classes in which the Directed Market Maker receives
Directed Orders (rather than on an option-by-option basis). Once a
Directed Market Maker receives a Directed Order, the heightened quoting
obligation is triggered and applies to the options in which the
Directed Market Maker receives the Directed Order. The Directed Market
Maker would be required to comply with the heightened quoting
requirements only upon receiving a Directed Order in a class, and the
heightened quoting requirements would be applicable until the end of
the calendar month.
III. Discussion
Under Section 19(b)(2)(C) of the Act, the Commission shall approve
a proposed rule change of a self-regulatory organization if the
Commission finds that such proposed rule change is consistent with the
requirements of the Act, and the rules and regulations thereunder that
are applicable to such organization.\20\ The Commission shall
disapprove a proposed rule change if it does make such a finding.\21\
The Commission's Rules of Practice, under Rule 700(b)(3), state that
the ``burden to demonstrate that a proposed rule change is consistent
with the [Act] . . . is on the self-regulatory organization that
proposed the rule change'' and that a ``mere assertion that the
proposed rule change is consistent with those requirements . . . is not
sufficient.'' \22\
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\20\ 15 U.S.C. 78s(b)(2)(C)(i).
\21\ 15 U.S.C. 78s(b)(2)(C)(i); see also 17 CFR 201.700(b)(3)
and note 25 infra, and accompanying text.
\22\ 17 CFR 201.700(b)(3). The description of a proposed rule
change, its purpose and operation, its effect, and a legal analysis
of its consistency with applicable requirements must all be
sufficiently detailed and specific to support an affirmative
Commission finding. See id. Any failure of a self-regulatory
organization to provide the information solicited by Form 19b-4 may
result in the Commission not having a sufficient basis to make an
affirmative finding that a proposed rule change is consistent with
the Act and the rules and regulations issued thereunder that are
applicable to the self-regulatory organization. Id.
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After careful consideration, the Commission does not find that the
proposed rule change is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange.\23\ In particular, the Commission does not find
that the proposed rule change is consistent with Section 6(b)(5) of the
Act,\24\ which requires that the rules of a national securities
exchange be designed, among other things, to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade, to remove impediments to and perfect the mechanism
of a free and open market and a national market system, and to protect
investors and the public interest.
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\23\ In disapproving the proposed rule change, the Commission
has considered the proposed rule's impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
\24\ 15 U.S.C. 78f(b)(5).
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In the Order Instituting Proceedings, the Commission summarized the
comments received and BX's response, and noted several concerns that
raise questions as to whether the BX proposal is consistent with the
requirements of Section 6(b)(5) of the Act, including whether the
proposed process for handling Directed Orders would promote just and
equitable principles of trade, perfect the mechanism of a free and open
market and the national market system, or protect investors and the
public interest.\25\ Specifically, the Commission stated that the
proposal raises the following issues: (1) Whether BX's proposal would
protect investors in that the proposal would provide Directed Market
Makers with priority for Directed Allocations ahead of public customer
limit orders that arrived first in time; and (2) how the proposed rules
[[Page 65398]]
would impact quote competition on BX, and how any impact on quote
competition on BX in turn would impact execution quality on BX.\26\ The
Commission invited interested persons to submit written views with
respect to these concerns. The Commission received three letters in
response to the Order Instituting Proceedings, two of which were from
BX.\27\
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\25\ See Order Instituting Proceedings, supra note 4, at 34686.
\26\ Id.
\27\ See BX Letter 2, supra note 9 and NYSE Euronext Letter 3,
supra note 10; see also BX Letter 3, supra note 11.
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The Commission recognizes that it has previously approved rules of
other national securities exchanges that provide for directed order
programs.\28\ BX's proposed Directed Order rules, however, deviate from
the directed order rules of other exchanges previously approved by the
Commission, as described in more detail below. First, BX proposes to
provide a Directed Market Maker time priority over pre-existing
customer orders in certain instances. In addition, unlike other
exchanges with directed order programs, BX would not require its
Directed Market Makers to quote at the NBBO at the time a Directed
Order is received to be eligible to receive an execution guarantee;
rather, BX would only require its Directed Market Makers to be at the
NBBO at the time the Directed Order is executed. BX also deviates from
other exchanges in its proposal to apply heightened quoting
requirements only after a Directed Market Maker receives a Directed
Order in a given month.
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\28\ See Securities Exchange Act Release No. 51759 (May 27,
2005), 70 FR 32860 at 32861 (June 6, 2005) (SR-Phlx-2004-91) (``Phlx
Order''); see also e.g., Securities Exchange Act Release Nos. 47628
(April 3, 2003), 68 FR 17697 (April 10, 2003) (SR-CBOE-00-55)
(``CBOE Order''); 52331 (August 24, 2005), 70 FR 51856 (August 31,
2005) (SR-ISE-2004-16) (``ISE Order''); 59472 (February 27, 2009) 74
FR 9843 (March 6, 2009) (SR-NYSEALTR-2008-14) (``NYSEALTR Order'');
60469 (August 10, 2009), 74 FR 41478 (August 17, 2009) (SR-NYSEArca-
2009-73) (``NYSE Arca Notice''); and 68070 (October 18, 2012), 77 FR
65037 (October 18, 2012) (SR-C2-2012-24) (``C2 Order'').
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A. No Public Customer Priority
As outlined above, BX's proposed Directed Order rule would provide,
in options classes utilizing the price/time allocation methodology, the
Directed Market Maker with priority for the 40% allocation ahead of
public customer orders. Specifically, the Directed Market Maker's
allocation would go ahead of public customer orders that otherwise had
time priority over the Directed Market Maker's quote.
NYSE Euronext commented on this aspect of BX's proposal, noting
that, under BX's proposal, a Directed Market Maker that submits a quote
after a public customer who has aggressively improved the NBBO would
receive a Directed Allocation that the earlier-arriving public customer
could potentially have completely filled. According to NYSE Euronext,
public customers would not be fully rewarded for providing an
aggressive quote and thus the incentives to improve the NBBO would
decrease, resulting in fewer displayed public customer orders and fewer
public customers willing to improve the NBBO.\29\
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\29\ See NYSE Euronext Letter 2, supra note 6, at 3-4.
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In response to NYSE Euronext's comment letter, BX argues that
customer priority is not mandated by the Act or the rules and
regulations thereunder.\30\ BX also argues that it is reasonable and
consistent with applicable statutory standards for a Directed Market
Maker's quote to execute against a Directed Order before a priority
customer order that goes ahead of the Directed Market Maker quote in
time priority, stating that public customer orders are not precluded
from participating in the trade, but rather continue to stand in time
priority once the Directed Order's execution guarantee is
satisfied.\31\ BX contends that public customers may not have otherwise
received an execution on BX because the Directed Market Maker may have
attracted the Directed Order to BX as a result of the Directed Market
Maker's relationship with the order flow provider.\32\
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\30\ See BX Letter 2, supra note 9, at 3.
\31\ See Notice, supra note 3, at 15388. See also BX Letter 2,
supra note 9, at 3-4.
\32\ Id.
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NYSE Euronext also notes the longstanding history of distinguishing
public customers from professionals and allowing advantages to public
customer orders.\33\ NYSE Euronext states its belief that BX is
attempting to ``turn this distinction [between a public customer and a
professional] on its head'' by providing preferential treatment to
sophisticated professionals rather than public customers.\34\ NYSE
Euronext argues further that it would be inconsistent with the
protection of investors if other exchanges followed the approach of
treating directed orders in the same manner as BX, resulting in public
customers losing priority and receiving fewer fills.\35\
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\33\ See NYSE Euronext Letter 2, supra note 6, at 3-4.
\34\ See NYSE Euronext Letter 3, supra note 10, at 4. See also
NYSE Euronext Letter 2, supra note 6, at 2-3.
\35\ See NYSE Euronext Letter 3, supra note 10, at 5. (citing
Securities Exchange Act Release No. 42808 (May 22, 2000), 65 FR
34515, 34517 (May 30, 2000) (SR-ISE-00-01)).
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In response, BX states its view that the distinction between public
customers and professionals was rooted in floor-based trading models
where customers were not charged fees and in pro rata priority models
where there were opportunities for professionals to ``size out'' public
customers, therefore there was a particular need for public customer
priority.\36\ BX argues that currently other trading models are used by
the options exchanges, and that under a price/time model public
customers do not need the same protection as under a pro rata model. BX
also argues that its proposal rewards a specific category of market
participants who have general market making obligations that are
critical to the functioning of the market in addition to enhanced
obligations, which qualify them for a Directed Allocation.\37\ In
response to NYSE Euronext's argument that it would be inconsistent with
the protection of investors if other exchanges followed the approach of
treating directed orders in the same manner as BX, BX notes that NYSE
Euronext can choose not to adopt a similar approach on its markets, and
if BX's proposed approach is not successful based on its treatment of
customer orders, NYSE Euronext might benefit.\38\ BX also reiterates
its argument that Directed Orders attract liquidity to the Exchange,
and that a customer order on BX could remain unfilled if a Directed
Order is not routed to BX, in favor of another option exchange that
would allow the order to be directed to a particular market maker.\39\
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\36\ See BX Letter 2, supra note 9, at 3.
\37\ See BX Letter 3, supra note 11, at 2.
\38\ Id.
\39\ Id.; see also BX Letter 2, supra note 9, at 3-4.
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The directed order rules of other exchanges all provide for public
customer priority over directed order market makers at a particular
price level, whether the exchange has a pro-rata allocation methodology
or a price/time allocation methodology.\40\ The
[[Page 65399]]
rules of the one options exchange that has a directed order program in
a price/time allocation market do not allow the directed market maker
participation entitlement to step ahead of customer orders that have
time priority over the directed market maker's quote or order.\41\
Similar to the other exchanges, under BX's proposal, if the option is
subject to the pro-rata execution algorithm, public customer limit
orders resting on the limit order book at the execution price will
execute against the Directed Order first, before the 40% allocation to
the Directed Market Maker.\42\ To the contrary, however, BX's proposal
would not protect any public customer orders under a price/time
allocation methodology. Instead, it would allow the Directed Market
Maker's quote or order to go ahead of earlier-arriving public customer
orders based solely on the relationship of the Directed Market Maker
with the order flow provider that sent the Directed Order.
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\40\ See, e.g., C2 Rules 6.12 and 8.17; CBOE Rule 8.13; NYSE
Rule 964NY; and ISE Rule 713 (pro-rata allocation methodology) and
NYSE Arca Rule 6.76A (time priority allocation methodology. See,
e.g., Securities Exchange Act Release 42808 (May 22, 2000), 65 FR
34515, 34517 (May 30, 2000) (SR-ISE-00-01) (``Although the
Commission recognizes that intramarket competition, as well as
protection of public customers, could be compromised if such a
participation right constituted an absolute guarantee or if it
consumed too great a percentage of order flow, the Commission
believes that the ISE's proposal sets forth reasonable safeguards
against such potential harms. The ISE's proposal prioritizes public
customer limit orders on the book. Indeed, if sufficient existing
customer interest exists a PMM might not receive any allocation of a
given incoming order. . . . The Commission believes that these
limits on a PMM's participation right should assure reasonable
protection for public customers and prevent impediments to a free
and open market that might otherwise result from an absolute
specialist guarantee.'') (order approving rules related to market
maker participation rights).
\41\ See NYSE Arca Rule 6.76A, which provides that the
participation entitlement has priority over other orders except
customer orders that were ranked ahead of the directed market
maker's quote or order in time priority. See NYSE Arca Notice, supra
note 28, at 41479.
\42\ Proposed BX Chapter VI, Section 10(3)(i)(B).
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The Commission believes that BX's failure to accord protection to
public customer orders would result in an execution allocation that is
inconsistent with Section 6(b)(5) of the Act, which requires that the
rules of an exchange must designed, among other things, to protect
investors.\43\ Specifically, rather than giving priority to public
customer orders or placing public customers and Directed Market Makers
on an equal footing, BX's proposal would, by allowing Directed Market
Maker quotes or orders to ``jump'' the price/time queue over previously
received public customers limit orders, disadvantage public customer
orders in order to give a trading benefit to Directed Market Makers in
contravention of Section 6(b)(5) of the Exchange Act.\44\
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\43\ 15 U.S.C. 78f(b)(5).
\44\ 15 U.S.C. 78f(b)(5).
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B. NBBO Quoting Requirement
Unlike other exchanges with directed order programs, BX would not
require its Directed Market Makers to be quoting at the NBBO at the
time a Directed Order is received to be eligible to receive an
execution guarantee.\45\ Rather, BX would only require its Directed
Market Makers to be quoting at the NBBO at the time the Directed Order
is executed.\46\ In its filing, BX supports this aspect of its proposal
by stating its belief that because executions occur across multiple
prices with simultaneous routing, the availability of the participation
entitlement should not be limited by the requirement that Directed
Market Makers be quoting at the NBBO at the time the Directed Order is
received.\47\
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\45\ See, e.g., Securities Exchange Act Release 51818 (June 10,
2005), 70 FR 35146, 35149-50 (June 16, 2005) (SR-ISE-2005-18) (``The
Commission has previously approved rules that guarantee a Primary
Market Maker a portion of each order when the Primary Market Maker's
quote is equal to the NBBO . . . . [A] Preferred Market Maker will
have to be quoting at the NBBO at the time the Preferenced Order is
received to capitalize on the participation guarantee. The
Commission believes it is critical that the Preferred Market Maker
cannot step up and match the NBBO after it receives an order, but
must be publicly quoting at that price when the order is
received.'') (order approving rules relating to preferencing of
market maker orders).
\46\ Under BX's proposal, if the Directed Market Maker is not at
the NBBO at the time a Directed Order is received, the order would
first execute against available interest at the NBBO. If the orders
at the NBBO on BX and on away markets are executed so that the
Directed Market Maker is at the NBBO, and there is remaining size
available from the Directed Order, the Directed Market Maker would
receive its execution guarantee (40% of the remaining shares) at
each price level at which the Directed Market Maker has quotes/
orders.
\47\ See Notice, supra note 3, at 15389.
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NYSE Euronext expressed concern with BX's proposed rule to allow a
Market Maker to receive a Directed Allocation when the Market Maker
does not have a quote at the NBBO at the time the Directed Order is
received by BX. NYSE Euronext stated that in approving rule proposals
that guarantee an allocation to a market maker, the Commission has
consistently focused on two distinct aspects of the proposals, one of
which is that the market maker's quote is equal to the NBBO at the time
of receipt of the order.\48\ NYSE Euronext states that the Commission
has granted the increased reward of a preferential directed order
allocation only to market makers who are taking the commensurate risk
of quoting at the NBBO, and appropriately so: posting firm quotes
acceptable by all participants at the NBBO is a benefit to all
participants in that it fosters price discovery and transparency.\49\
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\48\ See NYSE Euronext Letter 2, supra note 6, at 2.
\49\ See NYSE Euronext Letter 1, supra note 4, at 5.
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NYSE Euronext states that BX's proposed rule would be unprecedented
and would be detrimental to transparency and price discovery by
destroying incentives for market makers to quote aggressively at the
NBBO.\50\ Specifically, NYSE Euronext argues that by rewarding market
makers whose quotes are not the most aggressive, the BX proposal will
encourage market makers to quote away from the inside market, and that
the Exchange's proposal would deteriorate market makers' incentives to
compete for incoming orders based on price.\51\ According to NYSE
Euronext, a market maker could ``lay in wait'' outside the NBBO,
allowing other participants to participate in the order at less
attractive prices, while the market maker receives a 40% participation
entitlement for that portion of the Directed Order that trades at the
more attractive price.\52\ NYSE Euronext also believes that Directed
Market Makers will have no incentive to match or improve the NBBO of a
thinly traded option due to the low risk that a Directed Order will be
fully executed against a better-priced order.\53\
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\50\ Id.
\51\ See NYSE Euronext Letter 2, supra note 6, at 1.
\52\ See NYSE Euronext Letter 1, supra note 4, at 5.
\53\ See NYSE Euronext Letter 2, supra note 6, at 4.
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NYSE Euronext further argues that, although BX believes its
proposed rule will increase depth of market, BX fails to acknowledge
that such an increase would be the result of fewer Directed Market
Makers quoting at the NBBO.\54\ Rather than create additional
liquidity, NYSE Euronext believes that BX's proposal would shift
liquidity from the top-of-book to depth-of-book.\55\
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\54\ See NYSE Euronext Letter 3, supra note 10, at 2.
\55\ Id. at 4.
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In response to these concerns, BX acknowledges that its proposal
does break new ground, but stresses that to receive an execution of a
Directed Order, a Directed Market Maker must be quoting at the NBBO at
the time of execution, and that there would never be an allocation to a
quote outside the NBBO.\56\ BX maintains that its proposed program will
help make market makers quote more competitively, not less.\57\
Specifically, BX notes that, in order for a Directed Market Maker to
execute an order at a particular price, all orders at more aggressive
prices will first have to be executed.\58\ As a result, BX believes
that Directed Market Makers will be incentivized to provide their best
quote and add depth to the market.\59\
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\56\ See BX Letter 1, supra note 5, at 2.
\57\ See BX Letter 3, supra note 11, at 2.
\58\ See BX Letter 1, supra note 5, at 3.
\59\ Id.
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BX also argues that a market maker who chooses to quote at a price
other than the inside is providing value and depth at that price when
orders trade at
[[Page 65400]]
multiple price levels and when that price becomes the NBBO, thus
benefitting investors.\60\ In particular, BX argues that its proposal
addresses the reality of multiple prices and creates an ability to
efficiently execute a larger volume of an order, particularly when the
NBBO is for a small size. Thus, according to BX, its proposal
``recognizes the new NBBO and preserves the requirement that the
Directed Market Maker be at the NBBO'' (emphasis in original).\61\
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\60\ See BX Letter 1, supra note 5, at 3. See also BX Letter 2,
supra note 9, at 2.
\61\ See BX Letter 1, supra note 5, at 2. See also BX Letter 2,
supra note 9, at 2, 4.
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BX disagrees with NYSE Euronext's contention that liquidity would
be shifted from the top-of-book to depth-of-book. BX instead contends
that market participants and market makers in particular have
independent and varied motivations for their pricing decisions and
pricing points and that a directed order program would not affect those
motivations.\62\ BX argues that a market maker who chooses to quote at
a price other than the inside is providing value and depth at that
price when orders trade at multiple price levels as well as when that
price level becomes the NBBO.\63\
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\62\ See BX Letter 3, supra note 11, at 2.
\63\ Id.
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The Commission has considered the arguments raised by both BX and
NYSE Euronext. On the one hand, the existing requirement to be quoting
at the NBBO in order to receive a directed order may incentivize market
makers to quote tighter spreads, and therefore contribute to more
efficient markets. On the other hand, BX's proposal to allow Directed
Market Makers to receive Directed Orders when they are not quoting at
the NBBO at the time of receipt of the Directed Order may, as BX
argues, contribute to greater depth in the market, which also could
contribute to market efficiency. However, BX has not provided
sufficient information in its proposal to overcome the Commission's
fundamental concerns about the impact the proposal could have on
participants' incentives to quote competitively and the potential
impact on overall prices in the market. For example, a directed market
maker's incentive to quote in the depth-of-book is likely related to
the frequency with which marketable orders execute against not just the
NBBO but also the depth-of-book. BX, however, has not provided any
analysis regarding the frequency or nature of such marketable orders or
any data showing the interaction of such orders with the market makers'
orders or quotes. Accordingly, the Commission does not believe that BX
has met its burden in demonstrating that this aspect of the proposed
rule change is consistent with the Act.\64\
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\64\ 17 CFR 201.700(b)(3).
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C. Application of Heightened Quoting Requirement
The rules approved by the Commission governing the directed order
programs of other options exchanges require that directed market makers
on those exchanges satisfy quoting requirements that are higher than
those imposed on market makers not receiving directed orders.\65\ BX
also would impose a heightened quoting requirement on its Directed
Market Makers that receive Directed Orders. However, unlike the
directed order rules in place at other options exchanges, BX proposes
that the heightened quoting requirements for its Directed Market Makers
apply only after the Directed Market Maker receives its first Directed
Order in a given month. BX argues that this provision is appropriate
because a Directed Market Maker does not know if and when it will
receive a Directed Order, and therefore should not be required to quote
at a heightened level unless and until it receives a Directed
Order.\66\ BX also argues that if the Directed Market Maker is not
quoting, the Directed Order will not execute against such Directed
Market Maker and thus the Directed Market Maker has an incentive to
quote competitively in as many series as possible to attract Directed
Orders. BX then asserts its view that this provision properly balances
the benefit of receiving enhanced allocations with the obligations of
heightened quoting.\67\
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\65\ See C2 Rule 8.17; CBOE Rule 8.13; ISE Rule 811; NYSE Rule
964NY; NYSEArca Rule 6.88; and Phlx Rule 1014.
\66\ See BX Letter 2, supra note 9, at 4. The proposal would
allow a Market Maker to accept Directed Orders at the end of each
month and then only quote at a heightened level for the remainder of
that month.
\67\ Id.
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The Commission does not believe that BX has sufficiently
demonstrated why requiring Directed Market Makers to be quoting at a
heightened level only after receiving a Directed Order would not
inappropriately upset the balance between a Directed Market Maker's
obligations (including quoting obligations) and the benefits it
receives (i.e., its participation entitlement). Accordingly, the
Commission does not believe that BX has met its burden in demonstrating
that this aspect of the proposed rule change is consistent with the
Act.\68\
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\68\ 17 CFR 201.700(b)(3).
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IV. Conclusion
For the reasons set forth above, the Commission does not believe
that BX has met its burden to demonstrate that the proposed rule change
is consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities exchange,
and in particular, Section 6(b)(5) of the Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the Act,
that the proposed rule change (SR-BX-2013-016) be, and hereby is,
disapproved.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\69\
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\69\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-25829 Filed 10-30-13; 8:45 am]
BILLING CODE 8011-01-P