Proposed Rule2022-01975
Amendments Regarding the Definition of “Exchange” and Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities, National Market System (NMS) Stocks, and Other Securities
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
March 18, 2022
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is proposing to amend Rule 3b-16 under Securities Exchange Act of 1934 ("Exchange Act"), which defines certain terms used in the statutory definition of "exchange" under Section 3(a)(1) of the Exchange Act to include systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities. In addition, the Commission is re-proposing amendments to its regulations under the Exchange Act that were initially proposed in September 2020 for ATSs to take into consideration systems that may fall within the definition of exchange because of the proposed amendments and operate as an ATS. The Commission is re-proposing, with certain revisions, amendments to its regulations for ATSs that trade government securities as defined under Section 3(a)(42) of the Exchange Act ("government securities") or repurchase and reverse repurchase agreements on government securities ("Government Securities ATSs"). The Commission is also proposing to amend Form ATS-N for NMS Stock ATSs, which would require existing NMS Stock ATSs to amend their existing disclosures. In addition, the Commission is proposing to amend the fair access rule for ATSs. The Commission is also proposing to require electronic filing of and to modernize Form ATS-R and Form ATS, which would require existing Form ATS filers to amend their existing disclosures. Further, the Commission is re-proposing amendments to its regulations regarding systems compliance and integrity to apply to ATSs that meet certain volume thresholds in U.S. Treasury Securities or in a debt security issued or guaranteed by a U.S. executive agency, or government-sponsored enterprise ("Agency Securities").
Full Text
<html>
<head>
<title>Federal Register, Volume 87 Issue 53 (Friday, March 18, 2022)</title>
</head>
<body><pre>
[Federal Register Volume 87, Number 53 (Friday, March 18, 2022)]
[Proposed Rules]
[Pages 15496-15696]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-01975]
[[Page 15495]]
Vol. 87
Friday,
No. 53
March 18, 2022
Part II
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Parts 232, 240, 242, et al.
Amendments Regarding the Definition of ``Exchange'' and Alternative
Trading Systems (ATSs) That Trade U.S. Treasury and Agency Securities,
National Market System (NMS) Stocks, and Other Securities; Proposed
Rule
Federal Register / Vol. 87 , No. 53 / Friday, March 18, 2022 /
Proposed Rules
[[Page 15496]]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 232, 240, 242, and 249
[Release No. 34-94062; File No. S7-02-22]
RIN 3235-AM45
Amendments Regarding the Definition of ``Exchange'' and
Alternative Trading Systems (ATSs) That Trade U.S. Treasury and Agency
Securities, National Market System (NMS) Stocks, and Other Securities
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing to amend Rule 3b-16 under Securities Exchange Act of 1934
(``Exchange Act''), which defines certain terms used in the statutory
definition of ``exchange'' under Section 3(a)(1) of the Exchange Act to
include systems that offer the use of non-firm trading interest and
communication protocols to bring together buyers and sellers of
securities. In addition, the Commission is re-proposing amendments to
its regulations under the Exchange Act that were initially proposed in
September 2020 for ATSs to take into consideration systems that may
fall within the definition of exchange because of the proposed
amendments and operate as an ATS. The Commission is re-proposing, with
certain revisions, amendments to its regulations for ATSs that trade
government securities as defined under Section 3(a)(42) of the Exchange
Act (``government securities'') or repurchase and reverse repurchase
agreements on government securities (``Government Securities ATSs'').
The Commission is also proposing to amend Form ATS-N for NMS Stock
ATSs, which would require existing NMS Stock ATSs to amend their
existing disclosures. In addition, the Commission is proposing to amend
the fair access rule for ATSs. The Commission is also proposing to
require electronic filing of and to modernize Form ATS-R and Form ATS,
which would require existing Form ATS filers to amend their existing
disclosures. Further, the Commission is re-proposing amendments to its
regulations regarding systems compliance and integrity to apply to ATSs
that meet certain volume thresholds in U.S. Treasury Securities or in a
debt security issued or guaranteed by a U.S. executive agency, or
government-sponsored enterprise (``Agency Securities'').
DATES: Comments should be received on or before April 18, 2022.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/regulatory-actions/how-to-submit-comments">https://www.sec.gov/regulatory-actions/how-to-submit-comments</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#d0a2a5bcb5fdb3bfbdbdb5bea4a390a3b5b3feb7bfa6"><span class="__cf_email__" data-cfemail="750700191058161a1818101b0106350610165b121a03">[email protected]</span></a>. Please include
File Number S7-02-22 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-02-22. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (<a href="https://www.sec.gov/rules/proposed.shtml">https://www.sec.gov/rules/proposed.shtml</a>). Comments are also available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Operating conditions may limit access to the
Commission's public reference room. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at <a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Regulation ATS: Tyler Raimo, Assistant
Director, at (202) 551-6227; Matthew Cursio, Special Counsel, at (202)
551-5748; David Garcia, Special Counsel, at (202) 551-5681; Megan
Mitchell, Special Counsel, at (202) 551-4887; Amir Katz, Special
Counsel, at (202) 551-7653; and Joanne Kim, Attorney Advisor, at (202)
551-4393, and for Regulation SCI: David Liu, Special Counsel, at (312)
353-6265 and Sara Hawkins, Special Counsel, at (202) 551-5523, Office
of Market Supervision, Division of Trading and Markets, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing amendments to
the following rules under the Exchange Act: (1) 17 CFR 232.101 (Rule
101 of Regulation S-T); (2) 17 CFR 240.3b-16 (Rule 3b-16); (3) 17 CFR
242.300 (Rule 300 of Regulation ATS); \1\ (4) 17 CFR 242.301 (Rule 301
of Regulation ATS); (5) 17 CFR 242.302 (Rule 302 of Regulation ATS);
(6) 17 CFR 242.304 (Rule 304 of Regulation ATS); \2\ and (7) 17 CFR
242.1000 (Rule 1000 of Regulation SCI).\3\
---------------------------------------------------------------------------
\1\ ``Regulation ATS'' consists of 17 CFR 242.300 through
242.304 (Rules 300 through 304 under the Exchange Act). See also
Regulation ATS Adopting Release, infra note 31.
\2\ The Commission adopted Rule 304 on July 18, 2018. See
Securities Exchange Act Release No. 83663 (July 18, 2018), 83 FR
38768 (August 7, 2018) (``NMS Stock ATS Adopting Release'').
\3\ The Commission adopted 12 CFR 242.1000 through 242.1007
(Regulation SCI) on November 19, 2014. See Securities Exchange Act
Release No. 73639 (November 19, 2014), 79 FR 72252 (December 5,
2014) (``Regulation SCI Adopting Release'').
---------------------------------------------------------------------------
I. Introduction
In September 2020, the Commission issued a proposal to amend
Regulation ATS and Regulation SCI for Government Securities ATSs
(``2020 Proposal'').\4\ The Commission recognized the critical role of
government securities in the U.S. and global economy, the significant
volume in government securities transacted on systems currently
operating as ATSs, and these ATSs' growing importance to investors and
overall securities market structure. Notwithstanding their importance
for government securities, the investor protection and fair and orderly
market principles of Regulation ATS have limited application to
Government Securities ATSs.\5\ For
[[Page 15497]]
example, an ATS that limits its securities activities to government
securities or reverse repurchase agreements on government securities
(``repos'') and registers as a broker-dealer or is a bank (i.e., a
Currently Exempted Government Securities ATS) is exempt from exchange
registration and is not required to comply with Regulation ATS.
Further, ATSs that trade both government securities and non-government
securities (e.g., corporate bonds) are subject to Regulation ATS but
are not required to comply with many of its investor protection and
fair and orderly markets provisions, including public transparency
rules and the obligation to provide fair access to investors if the ATS
has significant trading volume. In addition, ATSs that trade government
securities are not subject to the systems integrity provisions of
Regulation SCI.
---------------------------------------------------------------------------
\4\ See Securities Exchange Act Release No. 90019 (September 28,
2020), 85 FR 87106 (December 31, 2020).
\5\ For the purposes of this re-proposal, the term ``Government
Securities ATS'' refers to an ATS that trades government securities
or repos and includes ATSs that would be subject to Regulation ATS
after the effective date of any final rule. This term includes three
categories of ATSs. First, a ``Currently Exempted Government
Securities ATS'' means an ATS that trades government securities or
repos, is operating as of the effective date of any final rule, and
was formerly not required to comply with Regulation ATS under 17 CFR
240.3a1-1(a)(3) (Exchange Act Rule 3a1-1(a)(3)) exemption prior to
the effective date of any final rule. Second, a ``Current Government
Securities ATS'' means an ATS that trades government securities or
repos and is operating pursuant to an initial operation report on
Form ATS on file with the Commission as of the effective date of any
final rule. Finally, when referring to regulatory requirements after
the effective date of any final rule, the term ``Government
Securities ATS'' also includes a Communication Protocol System that
trades U.S. Government securities or repos on U.S. Government
securities and that chooses to operate as an ATS after the effective
date of any final rule. A ``Communication Protocol System'' would
include a system that offers protocols and the use of non-firm
trading interest to bring together buyers and sellers of securities.
The re-proposal also uses the term ``Legacy Government Securities
ATS,'' which includes all ATSs that trade government securities or
repos and are operating as of the effective date of any final rule,
regardless of whether the ATSs are operating pursuant to an initial
operation report on Form ATS on file with the Commission (i.e., all
Current Government Securities ATSs and Currently Exempted Government
Securities ATSs).
---------------------------------------------------------------------------
To promote operational transparency, investor protection, system
integrity, fair and orderly markets, and regulatory oversight for
Government Securities ATSs, the Commission proposed in the 2020
Proposal to: Eliminate the exemption from compliance with Regulation
ATS for Currently Exempted Government Securities ATSs; require all
Government Securities ATSs to publicly file Form ATS-G, on which they
would disclose information about their operations and potential
conflicts of interest; provide a process for the Commission to review
Form ATS-G disclosures for clarity, completeness, and potential
violations of law and, if necessary, declare ineffective Form ATS-G
filings; and require an ATS that has significant volume for U.S.
Treasury Securities or Agency Securities to: (1) Establish reasonable
standards for access to the ATS and apply those standards to all
prospective and current subscribers in a fair and non-discriminatory
manner pursuant Rule 301(b)(5) of Regulation ATS (``Fair Access
Rule''); and (2) comply with the operational capability, security,
business continuity planning, incident reporting, and related
requirements under Regulation SCI.\6\ The Commission issued a concept
release (``Concept Release'') in addition to the 2020 Proposal on the
regulation of fixed income electronic trading platforms.\7\ The Concept
Release requested comments on a wide range of topics, including the
different regulatory treatment among fixed income electronic trading
platforms that use diverse trading protocols or business models and
various aspects of government securities, corporate bonds, and
municipal securities trading, including their operations, services,
fees, market data, and participants.
---------------------------------------------------------------------------
\6\ The Commission also had proposed to amend Regulation ATS to:
Require that Form ATS and Form ATS-R be filed with the Commission
electronically through the Electronic Data Gathering, Analysis and
Retrieval (EDGAR) system and modernize both forms; eliminate
confidential treatment of the types of securities that an ATS trades
as disclosed on the ATS's Form ATS and Form ATS-R; update and
correct Form ATS-N; change the reasons for which the Commission
could extend the initial Form ATS-N review period; require NMS Stock
ATSs to post on their websites the most recently disseminated Form
ATS-N, except for any amendment that the Commission has declared
ineffective or that has been withdrawn; and remove the exclusion
from compliance with the Fair Access Rule and Rule 301(b)(6) under
Regulation ATS for an ATS that matches non-displayed customer orders
using prices disseminated by an effective transaction reporting
plan.
\7\ See 2020 Proposal, supra note 4.
---------------------------------------------------------------------------
The Commission received comments in response to the 2020 Proposal
and Concept Release.\8\ Commenters expressed broad support for the 2020
Proposal. In general, commenters supported the proposed requirements to
remove the exemption for Currently Exempted Government Securities ATSs
and to require public disclosures on Form ATS-G.\9\ However, some
commenters expressed concern regarding aspects of the 2020 Proposal,
including the proposed enhanced disclosure requirements and
effectiveness regime \10\ and the proposal to require Government
Securities ATSs that meet certain volume thresholds to register as
national securities exchanges.\11\ In addition, commenters who opined
on the Fair Access Rule and Regulation SCI had differing views about
whether and how to apply them to Government Securities ATSs.\12\
---------------------------------------------------------------------------
\8\ These comment letters are available at <a href="https://www.sec.gov/comments/s7-12-20/s71220.htm">https://www.sec.gov/comments/s7-12-20/s71220.htm</a> and discussed throughout this proposal.
\9\ See, e.g., letter from Marcia E. Asquith, Executive Vice
President & Corporate Secretary, Financial Industry Regulatory
Authority, Inc., dated March 1, 2021 (``FINRA Letter'') at 2; letter
from Rob Toomey, Managing Director & Associate General Counsel,
Securities Industry and Financial Markets Association, Chris
Killian, Managing Director, Securitization and Credit, Securities
Industry and Financial Markets Association, and Leslie Norwood,
Managing Director, Associate General Counsel, Securities Industry
and Financial Markets Association, dated March 1, 2021 (``SIFMA
Letter'') at 2; letter from Elisabeth Kirby, Head of U.S. Market
Structure, Tradeweb Markets Inc., dated March 1, 2021 (``Tradeweb
Letter'') at 2; letter from Jennifer W. Han, Chief Counsel & Head of
Regulatory Affairs, Managed Funds Association, dated March 1, 2021
(``MFA Letter'') at 2-3; and Tyler Gellasch, Executive Director,
Healthy Markets Association, dated March 22, 2021 (``Healthy Markets
Letter'') at 7.
\10\ See letter from Robert Laorno, General Counsel, ICE Bonds
Securities Corporation, dated March 8, 2021 (``ICE Bonds Letter I'')
at 5.
\11\ See letter from Kathleen M. Cronin, Senior Managing
Director, General Counsel and Corporate Secretary, CME Group Inc.,
dated February 26, 2021 (``BrokerTec Letter'') at 3-4.
\12\ See, e.g., SIFMA Letter at 5 (supporting the proposed
volume thresholds); Americans for Financial Reform Education Fund,
dated March 1, 2021 (``AFREF Letter'') at 3 (supporting the proposed
threshold with respect to Regulation SCI and stating that they
believe the proposed threshold for the Fair Access Rule is too low);
Healthy Markets Letter at 10-11 (recommending a lower threshold for
Regulation SCI); letter from Gregory Babyak, Global Head of
Regulatory Affairs, Bloomberg L.P., dated March 1, 2021 (``Bloomberg
Letter'') at 5-6 (stating that the proposed thresholds are too
high); ICE Bonds Letter I at 5 (suggesting a 20 percent threshold
for application of Regulation SCI); Tradeweb Letter at 3, 11
(recommending a ``more material'' threshold for applying Regulation
SCI). See also infra Sections III.B.4 and III.C.
---------------------------------------------------------------------------
In addition, the Commission received substantial comment on the
Concept Release, in particular concerning the regulatory framework for
fixed income electronic trading platforms. Many commenters recognized
that certain electronic trading platforms for fixed income securities
are not regulated as registered exchanges or ATSs despite performing
the same market function as those regulated markets.\13\ Several
commenters expressed support for the Commission to expand the scope of
its exchange regulation to encompass more fixed income platforms,\14\
while several other commenters believed that such action is not
necessary or appropriate.\15\
---------------------------------------------------------------------------
\13\ See, e.g., letter from Stephen John Berger, Managing
Director, Global Head of Government and Regulatory Policy, Citadel,
dated March 1, 2021 (``Citadel Letter''); letter from Joanna
Mallers, Secretary, FIA Principal Traders Group, dated March 1, 2021
(``FIA PTG Letter'') at 2; letter from Robert Laorno, General
Counsel, ICE Bonds Securities Corporation, dated March 15, 2021
(``ICE Bonds Letter II'') at 2-4; FINRA Letter at 6; MFA Letter at
8; Tradeweb Letter at 4.
\14\ See, e.g., Citadel Letter; FIA PTG Letter; ICE Bonds Letter
II.
\15\ See, e.g., letter from Sarah A. Bessin, Associate General
Counsel, Investment Company Institute and Nhan Nguyen, Counsel,
Investment Company Institute, dated March 1, 2021 (``ICI Letter'')
at 2, 7; letter from Scott Pintoff, General Counsel, MarketAxess,
dated March 1, 2021 (``MarketAxess Letter'') at 2-4; Bloomberg
Letter at 17-20.
---------------------------------------------------------------------------
Advances in technology and innovation since Regulation ATS was
adopted in 1998 \16\ have changed the methods by which securities
markets bring together buyers and sellers of
[[Page 15498]]
securities. As discussed further below, innovations in trading
protocols have increased efficiencies and access to discover liquidity
and prices, search for a counterparty, and agree upon the terms of a
trade. Instead of using exchange markets that offer only the use of
firm orders and provide matching algorithms, market participants are
able to connect to numerous Communication Protocol Systems, which offer
the use of protocols and non-firm trading interest to bring together
buyers and sellers of securities. Communication Protocol Systems today
perform similar market place functions of bringing together buyers and
sellers as registered exchanges and ATSs and have become an
increasingly preferred choice of trading venue, particularly for fixed
income securities. However, as a function of how Exchange Act Rule 3b-
16 currently defines the terms in Section 3(a)(1) of the Exchange Act,
Communication Protocol Systems do not fall within the definition of
exchange. As a result, Communication Protocol Systems are not subject
to the same regulatory requirements as registered exchanges and ATSs
and the investors using them do not receive the investor protection,
fair and orderly markets, transparency, and oversight benefits stemming
from exchange regulation. Further, by Communication Protocol Systems
falling outside the definition of exchange, a disparity has developed
among similar markets that bring together buyers and sellers of
securities, in which some are regulated as exchanges and others are
not. This regulatory disparity can create a competitive imbalance and a
lack of investor protections.\17\
---------------------------------------------------------------------------
\16\ See Regulation ATS Adopting Release, infra note 31.
\17\ See infra Section VIII.C.3.a.
---------------------------------------------------------------------------
Given the changing conditions among markets to bring together
buyers and sellers of securities, and taking into consideration comment
letters submitted in response to the 2020 Proposal and the Concept
Release, the Commission is proposing to amend Exchange Act Rule 3b-16
regarding what ``shall be considered to constitute, maintain, or
provide `a market place or facilities for bringing together purchasers
and sellers of securities or for otherwise performing with respect to
securities the functions commonly performed by a stock exchange' as
those terms are used'' in the statutory definition of ``exchange''
under Exchange Act Section 3(a)(1).\18\ The proposed amendments to
Exchange Act Rule 3b-16(a) would include Communication Protocol Systems
that make available for trading any type of security, including, among
others, government securities, corporate bonds, municipal securities,
NMS stocks, equity securities that are not NMS stocks, private
restricted securities, repurchase agreements and reverse repurchase
agreements, foreign sovereign debt, and options. Including
Communication Protocol Systems within the definition of ``exchange''
would appropriately regulate a market place that brings together buyers
and sellers of securities, extend the benefits of the exchange
regulatory framework to investors that use such systems, and reduce
regulatory disparities among like markets.
---------------------------------------------------------------------------
\18\ 17 CFR 240.3b-16(a).
---------------------------------------------------------------------------
In addition, because the Commission is proposing to amend Exchange
Act Rule 3b-16 to include Communication Protocol Systems within the
definition of exchange and taking into consideration comments received
in response to the 2020 Proposal and the Concept Release, the
Commission is re-proposing and revising previously proposed amendments
to Regulation ATS and Regulation SCI for Government Securities ATSs
that include the following: \19\ (1) Re-proposing to eliminate the
exemption from compliance with Regulation ATS for an ATS that trades
only government securities or repos and is operated by a broker-dealer
or is a bank; (2) re-proposing, with certain revisions, to require a
Government Securities ATS that has significant volume for U.S. Treasury
Securities or Agency Securities to comply with the Fair Access Rule
under Regulation ATS and Regulation SCI; \20\ (3) re-proposing to apply
the enhanced disclosure and filing requirements of Rule 304 of
Regulation ATS, which are currently applicable to NMS Stock ATSs, to
all Government Securities ATSs; (4) proposing to require Government
Securities ATSs to file Form ATS-N, as revised, instead of previously
proposed Form ATS-G; \21\ (5) proposing several changes to Form ATS-N
that would be applicable to both Government Securities ATSs and NMS
Stock ATSs, including questions about the ATS's interaction with
related markets, liquidity providers, and activities the ATS undertakes
to surveil and monitor its market; (6) proposing amendments to Form
ATS-N that would require existing NMS Stock ATSs to file an amendment
to their existing disclosures on Form ATS-N; (7) proposing to add a new
type of amendment to Form ATS-N to report changes to fee disclosures;
(8) proposing to amend the Form ATS-N review and effectiveness process
to permit the Commission to extend the review period for Form ATS-N
amendments; \22\ (9) proposing to make certain changes to the Fair
Access Rule that would apply to all ATSs that are subject to the rule;
\23\ and (10) re-proposing electronic filing of Form ATS-R and Form ATS
and proposing certain changes to the categories of securities reported
on Form ATS-R.\24\
---------------------------------------------------------------------------
\19\ U.S. Treasury Securities and Agency Securities are not
classes of securities for purposes of Exchange Act Rule 3a1-1(b).
\20\ The Commission is re-proposing to amend Regulation ATS to
require that Form ATS and Form ATS-R be filed with the Commission
electronically through EDGAR and to modernize both forms; eliminate
confidential treatment of the types of securities that an ATS trades
as disclosed on the ATS's Form ATS and Form ATS-R; and remove the
exclusion from compliance with the Fair Access Rule and Rule
301(b)(6) under Regulation ATS for an ATS that matches non-displayed
customer orders using prices disseminated by an effective
transaction reporting plan. Covered ATSs would not be required to
post on their websites the most recently disseminated Form ATS-N,
but would be required to provide pursuant to Rule 304(b)(3)(i) a
direct URL hyperlink to the Commission's website that contains the
documents made public by the Commission under Rule 304(b)(2).
\21\ In the 2020 Proposal, the Commission proposed that
Government Securities ATSs file proposed Form ATS-G. Given the
significant overlap between proposed Form ATS-G and existing Form
ATS-N, the Commission is now proposing that Government Securities
ATSs file Form ATS-N, which is currently filed by NMS Stock ATSs,
and proposing to revise Form ATS-N to apply disclosures for
Government Securities ATSs that would fall under the proposed
definition of ``exchange.'' See Appendix A for the proposed
revisions to Form ATS-N. The Commission believes that this would
limit the number of unique forms and simplify filing requirements.
\22\ The Commission is also re-proposing to change the reasons
for which the Commission could extend the initial Form ATS-N review
period. See infra Section IV.A.
\23\ See infra Section V.A.
\24\ See infra Section V.B.
---------------------------------------------------------------------------
II. Proposed Amendments Regarding the Definition of Exchange
A. Exchange Regulatory Framework
Exchange Act Section 3(a)(1) states that the term ``exchange''
means any organization, association, or group of persons, whether
incorporated or unincorporated, which constitutes, maintains, or
provides a market place or facilities for bringing together purchasers
and sellers of securities or for otherwise performing with respect to
securities the functions commonly performed by a stock exchange as that
term is generally understood, and includes the market place and the
market facilities maintained by such exchange.\25\
---------------------------------------------------------------------------
\25\ See 15 U.S.C. 78c(a)(1).
---------------------------------------------------------------------------
Section 5 of the Exchange Act \26\ requires an organization,
association, or
[[Page 15499]]
group of persons that meets the definition of ``exchange'' under
Section 3(a)(1) of the Exchange Act,\27\ unless otherwise exempt, to
register with the Commission as a national securities exchange pursuant
to Section 6 of the Exchange Act.\28\ As discussed further below,
registered national securities exchanges are self-regulatory
organizations (``SROs''),\29\ and must comply with regulatory
requirements applicable to both national securities exchanges and
SROs.\30\
---------------------------------------------------------------------------
\26\ 15 U.S.C. 78e.
\27\ See infra note 31.
\28\ 15 U.S.C. 78f. A ``national securities exchange'' is an
exchange registered as such under Section 6 of the Exchange Act.
\29\ Section 3(a)(26) of the Exchange Act defines a self-
regulatory organization as any national securities exchange,
registered securities association, registered clearing agency, or
(with limitations) the Municipal Securities Rulemaking Board
(``MSRB''). See 15 U.S.C. 78c(a)(26). See also Securities Exchange
Act Release No. 76474 (November 18, 2015), 80 FR 80998, 81025
(December 28, 2015) (``NMS Stock ATS Proposing Release'') at 81000-
01 nn.20-26 and accompanying text (discussing certain differences
between certain obligations and benefits applicable to national
securities exchanges and those applicable to ATSs).
\30\ See, e.g., 15 U.S.C. 78f and 78s.
---------------------------------------------------------------------------
In the Exchange Act, Congress provided a broad definition of the
term ``exchange,'' permitting the Commission to apply the definition
flexibly as the securities markets evolve over time.\31\ In 1998, the
Commission adopted Regulation ATS.\32\ At that time, the Commission
recognized that advances in technology had increasingly blurred the
line between exchange and broker-dealer activities \33\ and that ATSs
that existed then were used by market participants as functional
equivalents of exchanges.\34\ To more accurately describe the range of
markets that performed exchange functions at that time, the Commission
concurrently adopted Exchange Act Rule 3b-16 to define terms \35\ used
in the statutory definition of ``exchange'' under Exchange Act Section
3(a)(1).
---------------------------------------------------------------------------
\31\ See Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844, 70850 and 70898 (December 22, 1998)
(``Regulation ATS Adopting Release''). See also 15 U.S.C. 78e and
78f. The Commission noted that it was recognized at the time the
Exchange Act was enacted that a regulatory structure for securities
exchanges would ``be of little value tomorrow if it is not flexible
enough to meet new conditions immediately as they arise and demand
attention in the public interest.'' See Regulation ATS Adopting
Release at 70898, n.520 (citing Commission, Report of the Special
Study of the Securities Markets of the Securities and Exchange
Commission, H.R. Doc. No. 95, 88th Cong., 1st Sess. Pt. 1 (1963) at
6 and S. Rep. No. 792, 73rd Cong., 2d Sess. (1934) at 5 (noting that
``exchanges cannot be regulated efficiently under a rigid statutory
program,'' and that ``considerable latitude is allowed for the
exercise of administrative discretion in the regulation of both'')).
\32\ See Regulation ATS Adopting Release, supra note 31, at
70850.
\33\ See id. at 70847.
\34\ See id.
\35\ The Commission adopted Exchange Act Rule 3b-16 under
Section 3(b) of the Exchange Act (power to define terms). 15 U.S.C.
78c(b).
---------------------------------------------------------------------------
In Exchange Act Rule 3b-16(a), the Commission defined these terms,
in light of the markets that existed at that time, to include any
organization, association, or group of persons that: (1) Brings
together the orders for securities of multiple buyers and sellers; and
(2) uses established, non-discretionary methods (whether by providing a
trading facility or by setting rules) under which such orders interact
with each other, and the buyers and sellers entering such orders agree
to the terms of a trade.\36\ Rule 3b-16(b) explicitly excluded certain
systems that the Commission believed were not exchanges.\37\
Accordingly, a system is not included in the Commission's
interpretation of ``exchange'' if: (1) The system fails to meet the
two-part test in paragraph (a) of Rule 3b-16; (2) the system falls
within one of the exclusions in paragraph (b) of Rule 3b-16; or (3) the
Commission otherwise conditionally or unconditionally exempts \38\ the
system from the definition.
---------------------------------------------------------------------------
\36\ See 17 CFR 240.3b-16(a).
\37\ See Regulation ATS Adopting Release, supra note 31, at
70852. Specifically, Rule 3b-16(b) excludes from the definition of
exchange systems that perform only traditional broker-dealer
activities, including: Systems that route orders to a national
securities exchange, a market operated by a national securities
association, a broker-dealer for execution, or systems that allow
persons to enter orders for execution against the bids and offers of
a single dealer if certain additional conditions are met.
\38\ See 17 CFR 240.3b-16(e).
---------------------------------------------------------------------------
When the Commission adopted Exchange Act Rule 3b-16, the Commission
also adopted Exchange Act Rule 3a1-1(a) to exempt ATSs from the
definition of ``exchange'' under Section 3(a)(1) of the Exchange Act.
Exchange Act Rule 3a1-1(a)(2) \39\ exempts from the Exchange Act
Section 3(a)(1) definition of ``exchange'' an organization,
association, or group of persons that complies with Regulation ATS,\40\
which requires, among other things, meeting the definition of an ATS
and registering as a broker-dealer.\41\ Rule 300(a) of Regulation ATS
defines an ATS as any organization, association, person, group of
persons, or system: (1) That constitutes, maintains, or provides a
market place or facilities for bringing together purchasers and sellers
of securities or for otherwise performing with respect to securities
the functions commonly performed by a stock exchange within the meaning
of Rule 3b-16; and (2) that does not: (i) Set rules governing the
conduct of subscribers other than the conduct of such subscribers'
trading on such organization, association, person, group of persons, or
system; or (ii) discipline subscribers other than by exclusion from
trading.\42\ Governing the conduct of or disciplining subscribers are
functions performed by an SRO that the Commission believed should be
regulated as such.\43\ Accordingly, pursuant to Rule 300(a), a trading
system that performs SRO functions or functions common to national
securities exchanges, such as establishing listing standards, is
precluded from the definition of ATS and would be required to register
as a national securities exchange, be operated by a national securities
association, or seek another exemption.\44\
---------------------------------------------------------------------------
\39\ See 17 CFR 240.3a1-1(a)(2).
\40\ See id. Rule 3a1-1 also provides two other exemptions from
the definition of ``exchange'' for any ATS operated by a national
securities association and any ATS not required to comply with
Regulation ATS pursuant to Rule 301(a) of Regulation ATS. See 17 CFR
240.3a1-1(a)(1) and (3).
Rule 3a1-1(b) provides an exception to the Rule 3a1-1(a)
exemptions pursuant to which the Commission may require a trading
system that is a substantial market to register as a national
securities exchange, if the Commission finds doing so is necessary
or appropriate in the public interest or consistent with the
protection of investors. See 17 CFR 240.3a1-1(b). See also
Regulation ATS Adopting Release, supra note 31, at 70857-58.
\41\ See 17 CFR 242.300(a); 17 CFR 242.301(a); and 17 CFR
242.301(b)(1). In addition to the other requirements of Regulation
ATS, to qualify for the Rule 3a1-1(a) exemption, an organization,
association, or group of persons must otherwise meet the definition
of ``exchange.''
\42\ See 17 CFR 242.300(a).
\43\ See Regulation ATS Adopting Release, supra note 31, at
70859.
\44\ See id.
---------------------------------------------------------------------------
As a result of the exemption, an ATS that complies with Regulation
ATS is not required by Section 5 of the Exchange Act to register as a
national securities exchange, is not an SRO, and, therefore, is not
required to comply with regulatory requirements applicable to national
securities exchanges and SROs.\45\ An ATS that fails to comply with the
requirements of Regulation ATS would no longer qualify for the
exemption provided under Rule 3a1-1(a)(2), and thus, risks operating as
an unregistered exchange in violation of Section 5 of the Exchange
Act.\46\
---------------------------------------------------------------------------
\45\ See generally Sections 5, 6, and 19 of the Exchange Act, 15
U.S.C. 78e, 78f, and 78s.
\46\ See 15 U.S.C. 78e.
---------------------------------------------------------------------------
[[Page 15500]]
B. Adopting the Definition of Exchange for Evolving Market Places
1. Orders-Focused Markets Under Current Rule 3b-16
When the Commission adopted Exchange Act Rule 3b-16(a), the
Commission sought to more accurately describe the range of markets that
performed exchange functions as those were understood at that time.\47\
In the Regulation ATS Adopting Release, the Commission observed that
ATSs at that time provided services more akin to exchange functions
than broker-dealer functions, such as matching counterparties' orders,
executing trades, operating limit order books, and facilitating active
price discovery.\48\
---------------------------------------------------------------------------
\47\ See Regulation ATS Adopting Release, supra note 31, at
70900.
\48\ See id. at 70848.
---------------------------------------------------------------------------
In the Regulation ATS Adopting Release, the Commission identified
two elements of Exchange Act Rule 3b-16 that most accurately reflected
the functions and uses of exchange markets at that time. These elements
were the bringing together of orders of multiple buyers and sellers of
securities and that trading takes place according to established, non-
discretionary rules or procedures.\49\ When considering what
constituted an exchange at that time, the Commission focused on the
expectations of the participants regarding how an execution would occur
without the discretion of the operator. Because orders instruct a
trading system to carry out the intention of participants in accordance
with programmed trading procedures, orders, along with established,
non-discretionary methods, contribute to how trading system
participants could understand and expect to receive an execution.\50\
In addition, the Commission stated that ``an essential indication of
the non-discretionary status of rules and procedures is that those
rules and procedures are communicated to the systems users'' and
``[t]hus, participants have an expectation regarding the manner of
execution--that is, if an order is entered, it will be executed in
accordance with those procedures and not at the discretion of a
counterparty or intermediary.'' \51\
---------------------------------------------------------------------------
\49\ See id. at 70900.
\50\ For example, the Commission stated in the Regulation ATS
Adopting Release that ``an alternative trading system that posts
firm orders to buy and sell a security does raise a certain
expectation of execution at those quoted prices'' and that ``[t]he
expectation is based on the life of the outstanding orders in the
system, rather than continuous two sided quotations published by
specialist and market makers.'' See id. at 70899, n.532.
\51\ See id. at 70900.
---------------------------------------------------------------------------
Further, at the time Exchange Act Rule 3b-16(a) was adopted, most
ATSs operating met the criteria of the rule in that they offered the
use of orders and algorithms that matched orders.\52\ ATSs at that time
allowed broker-dealers to place and execute orders on the system and
the systems functioned as limit order books where orders are executed
according to time, price, and size priority.\53\ Accordingly, orders
and established, non-discretionary methods undergirded Exchange Act
Rule 3b-16 to reflect functions of exchange markets at that time. When
discussing orders in the Regulation ATS Adopting Release, however, the
Commission stated that systems that displayed bona fide, non-firm
trading interest \54\ or did not establish rules or operate a trading
facility \55\ would not fall within Rule 3b-16(a).
---------------------------------------------------------------------------
\52\ See id. at 70899-900, n.536.
\53\ See id. at 70899, n.525.
\54\ See id. at 70850. In the Regulation ATS Adopting Release,
the Commission stated, ``[g]enerally, however, a system that
displays bona fide, non-firm indications of interest--including, but
not limited to indications of interest to buy or sell a particular
security without either prices or quantities associated with those
indications--will not be displaying ``orders'' and, therefore, not
fall within Rule 3b-16.'' See id.
\55\ See id. The Commission also stated that ``[u]nless a system
also establishes rules or operates a trading facility under which
subscribers can agree to the terms of their trades, the system will
not be included within Rule 3b-16, even if it brings together
`orders.' '' See id.
---------------------------------------------------------------------------
2. Prevalence of Systems Offering Non-Firm Trading Interest and
Structured Protocols
Advances in technology have facilitated innovations and more
efficient or diverse methods to bring together buyers and sellers of
securities.\56\ In the Commission's experience, Communication Protocol
Systems, which can use various technologies and connectivity, generally
offer the use of non-firm trading interest and establish protocols to
prompt and guide buyers and sellers to communicate, negotiate, and
agree to the terms of the trade without relying solely on the use of
orders. Below is a non-exhaustive list of some Communication Protocol
Systems.
---------------------------------------------------------------------------
\56\ See id. at 70848.
---------------------------------------------------------------------------
One example of a Communication Protocol System is a ``Request-for-
Quote'' (``RFQ'') system. RFQ systems are designed to allow market
participants to obtain quotes for a particular security by sending
messages to one or multiple potential respondents on the system
simultaneously. RFQ systems may be ``disclosed,'' in which case the
participants with established relationships interact only with each
other, or anonymous, in which case the parties may not have established
relationships. The system provider requires a participant to enter
information in a message, which may include the name of the initiator,
Committee on Uniform Securities ldentificalion Procedures (CUSIP)
number, side, and size. The system provider also provides protocols for
participants to communicate with each other and negotiate a price or
size of a trade. For example, participants receiving an RFQ message can
choose to interact with the initiator by responding within a time
period designated by the system provider with a priced quote. These
methods can serve the same function as auctions where the respondents
compete to offer the best price. The initiator can then select among
the quote responses that it wishes to interact with through the system
by either accepting one of multiple responses or rejecting all
responses within a period of time set by the system provider. The match
of the request and response results in an agreement to the terms of the
trade between a buyer and a seller, which then proceeds to post-trade
processing.\57\ An RFQ list protocol (``RFQ List''), which is a form of
RFQ protocol used commonly to trade U.S. Treasury Securities, may
include a collection of RFQ inquiries that are submitted as a group but
priced as individual items.\58\ The RFQ List (defined by each system
provider but generally more than two listed items) may be executed in
its entirety, in pieces, or not at all. A liquidity provider that is
responding to the list request may apply a ``good for'' time that is
associated with the executable prices provided.
---------------------------------------------------------------------------
\57\ Communication Protocol Systems also may offer a workup
functionality or blotter scraping functionality to gather non-firm
trading interest and facilitate the negotiation and execution of
trades. In a workup, a system may have a private phase, where the
two original contra-parties submitting orders can negotiate, and a
public phase where all subscribers can submit orders at the workup
price.
\58\ An RFQ List may be referred to as a Bid Wanted in
Competition (``BWIC'') or Offer Wanted in Competition (``OWIC'') in
the corporate bond market. Both serve a similar purpose to the RFQ
List in allowing the submitter to solicit bids and offers on a
number of securities at one time.
---------------------------------------------------------------------------
A Communication Protocol System could also include a system that
electronically displays continuous firm or non-firm trading interest,
or ``stream axes,'' in a security or type of security to participants
on the system. Axes typically represent an indication of
[[Page 15501]]
interest to sell or buy a bond (but can include firm quotes), and can
either serve as a starting point for negotiation between participants
or be executed immediately. Systems that stream axes take many forms.
Some system providers provide connectivity and protocols for
participants to electronically communicate and negotiate the terms of a
trade. Other system providers offer participants more automated
processes, whereby participants auto-execute against a streamed quote
and agree upon the terms of a trade without negotiation. Typically, the
system is programmed with permission options to allow participants to
decide who can or cannot receive their axes. In such a case, the
trading interest exchanged between the parties is typically firm and
functions as orders.
Conditional order systems may be Communication Protocol Systems
that offer the use of trading interest that may not be executable until
after a user takes subsequent action. For example, a system provider
may require conditional orders to contain a symbol, side, and size and
provide protocols for participants to send and receive invitation
messages to trade. The system would be designed for conditional orders
to match with other trading interest, which can either be a firm order
or another non-firm conditional order.\59\ Upon a match, the system may
send a firm-up invitation messages to both participants. The system
protocols may permit a participant using a conditional order to either
decline the firm-up invite, accept the firm-up invite, or counter the
response to firm up.\60\ During the time that the parties' trading
interest is matched until the invitation to firm-up expires, is
canceled, is executed, or is declined, the system protocols may require
that the non-firm trading interest be committed and the shares cannot
trade elsewhere.\61\ Using the system protocols, the matched parties
can modify the attributes of the non-firm trading interest (i.e.,
price, size) before accepting the firm-up invitation. To the extent
either a seller or buyer changes the attributes, an execution will only
occur if each contra-party's corresponding attributes will still be
met. If both matching parties accept the firm-up invite, the parties
would agree upon the terms of the trade and an execution would occur.
---------------------------------------------------------------------------
\59\ Based on Commission staff experience, some NMS Stock ATSs
disclose protocols to allow conditional orders to interact with the
ATS's limit order book, thereby increasing the interaction among
potential buyers and sellers and access to liquidity.
\60\ An order resting on an ATS limit order book that can
interact with a conditional order does not receive a firm-up invite
and therefore does not send firm-up responses.
\61\ Many conditional order and RFQ systems monitor their
participants' firm-up rates and may limit or deny the use of the
system by a participant if the participant's firm-up rate falls
below a certain percentage. While the system provider typically
monitors these firm-up rates to help ensure that participants do not
abuse the system, such monitoring and actions taken against
participants for not firming-up may incentivize participants to not
back away. Thus, conditional orders or RFQs can be firm in practice
and in this way may meet the definition of order under current
Regulation ATS. See 17 CFR 242.300(e) (``any firm indication of a
willingness to buy or sell a security'').
---------------------------------------------------------------------------
Other systems have developed to bring together buyers and sellers
of securities through the use of bilateral negotiation protocols and
non-firm trading interest. Negotiation systems focus on providing a
forum for buyers and sellers to see displayed non-firm trading
interest, access liquidity, find a counterparty, and negotiate a trade
through the use of their communication technology. The system may allow
participants to select certain pre-approved participants and then
exchange messages for purposes of agreeing to the terms of a trade.
Negotiation systems may have fewer parameters for communicating trading
interest than RFQ protocols; for example, negotiation systems provide
features that are designed to prompt participants to interact with each
other and provide parameters around that interaction, such as time for
responses or requirements on the content of the message. A system may
``scrape'' or obtain the symbol of trading interest that a participant
is seeking from the participant's order management or execution
management system and use that to alert other participants on its
system about potential contra-side interest in seeking to initiate a
negotiation. The market participants using negotiation systems may
complete a transaction outside of the system.
As trading in securities has become more electronic, Communication
Protocol Systems perform the function of a market place and have become
a preferred method for market participants to discover prices, find a
counterparty, and execute a trade, particularly for government
securities and other fixed income markets. One commenter on the 2020
Proposal and Concept Release, for example, stated that multilateral
trading venues using RFQ protocols are some of the most significant
multilateral trading venues operating in fixed income markets regulated
by the Commission, including the U.S. Treasury market.\62\ This
commenter stated that RFQ trading venues dominate the dealer-to-
customer segment of the U.S. Treasury market and in the aggregate
account for approximately 50 percent of total electronic trading volume
on multilateral U.S. Treasury trading venues.\63\ Another large
electronic trading venue for fixed income products estimated that its
average daily volume using an RFQ protocol increased from $223 million
in the second quarter of 2017 to $1.17 billion in the second quarter of
2021.\64\ Systems offering conditional order protocols have increased
over the past several years, particularly for trading NMS stocks.
Today, 26 NMS Stock ATSs have disclosed on their public Form ATS-N that
they send or receive messages indicating trading interest, such as
conditional orders.
---------------------------------------------------------------------------
\62\ See Citadel Letter at 1-2.
\63\ See id. This commenter noted that multilateral RFQ trading
venues are formally registered in other asset classes and
jurisdictions, and that there are ``well-established precedents'' to
delineate the scope of multilateral trading venues subject to
regulation.
\64\ Tradeweb Investor Presentation, July 2021, available at:
<a href="https://investors.tradeweb.com/static-files/e63caabf-d71d-46c0-9589-353fb8b93388">https://investors.tradeweb.com/static-files/e63caabf-d71d-46c0-9589-353fb8b93388</a>.
---------------------------------------------------------------------------
Communication Protocol Systems, like registered exchanges and ATSs,
offer their participants several benefits, including reducing
counterparty search costs, bringing together diverse market
participants, and making it efficient and simple to find a counterparty
and agree upon the terms of a trade. These systems improve price
discovery from the voice protocols that were used more widely in the
fixed income market in the past by offering participants systems and
protocols that are specifically designed to allow participants to
contact, and receive responses from, multiple potential counterparties
at one time, as opposed to the more time-consuming process of calling
each potential counterparty individually. RFQ protocols, for example,
allow an initiator to share and attempt to trade its entire trading
interest all at once. In contrast, under a limit order book model, for
example, the seeker of liquidity may find it can only execute its
trading interest in a piecemeal fashion. RFQs also allow initiators to
more easily demonstrate that they attempted to achieve best execution
by showing that the initiator sent requests for quotes to multiple
dealers for a security. In addition, participants may find conditional
orders attractive when seeking to trade at size or to avoid information
leakage.
While Communication Protocol Systems may bring together buyers and
sellers for all types of securities and allow participants to negotiate
a trade,
[[Page 15502]]
they are particularly useful to market participants to trade less
liquid securities, find counterparties for large size trades, and
minimize information leakage and adverse impact of large size trades.
For example, market participants can use Communication Protocol Systems
to post and see non-firm trading interest on several trading venues
simultaneously, thereby increasing their ability to find a counterparty
and reduce search costs. When resting non-firm trading interest on a
trading venue, market participants can use non-firm trading interest as
a tool to avoid the risk of double-execution.\65\ Participants that use
conditional orders, for example, may place the same trading interest at
various trading centers in search of liquidity because it would allow
them to accept or decline responses if they receive more than one.
Participants may find locating a counterparty on a limit order book
system for less liquid securities more difficult and choose instead to
use a Communication Protocol System, such as an RFQ system, because
such system allows the initiating participant to use non-firm trading
interest to solicit quotes from multiple market participants for less
liquid securities and negotiate a size or price for such securities.
---------------------------------------------------------------------------
\65\ For example, a market participant that rests the same non-
firm trading interest on two trading venues has the ability to back
away from one if both are lifted (i.e., preliminarily matched). In
such case, the market participant is able to complete one trade and
cancel or back away from the other.
---------------------------------------------------------------------------
3. Lack of Investor Protections and Disparate Regulation Among Market
Places
Given the changes in methods for bringing buyers and sellers
together over the past couple of decades, the contrast between market
place functions of exchanges that offer the use of orders and trading
facilities and systems that offer the use of trading interest and
protocols has become increasingly blurred. Both types of systems share
the same business objectives and engage in similar market activities;
however, one type of system is subject to the exchange regulatory
framework while the other is not.\66\ Today, Communication Protocol
Systems perform similar market place functions as registered exchanges
and ATSs and have become venues for investors to discover prices, find
a counterparty, and agree upon the terms of a trade. Because
Communication Protocol Systems do not fall within the definition of
``exchange'' and are thus not required to register as national
securities exchanges, they are not required to comply with the same
Federal securities laws and regulations applicable to registered
exchanges \67\ or ATSs.\68\ Market participants use Communication
Protocol Systems for certain advantages that these market places offer
for trading securities; however, when doing so, market participants
cannot avail themselves of the same investor protections, fair and
orderly market principles, and Commission oversight that apply to
today's registered exchanges or ATSs.\69\ This regulatory gap also
creates disparities that affect competitive balances among like market
places for securities.\70\ Consistent with the statutory definition of
``exchange'' in Exchange Act Section 3(a)(1), and as discussed above,
today Communication Protocol Systems provide a ``market place'' for
bringing together purchasers and sellers of securities.\71\ The current
proposal will use the flexibility granted to the Commission by Congress
to update Exchange Act Rule 3b-16 to address these developments in the
markets for securities, the corresponding lack of investor protections,
and disparate regulation among these markets.\72\
---------------------------------------------------------------------------
\66\ See U.S. Securities and Exchange Commission Fixed Income
Market Structure Advisory Committee (``FIMSAC''), Recommendation for
the SEC to Review the Framework for the Oversight of Electronic
Trading Platforms for Corporate and Municipal Bonds (July 16, 2018),
available at <a href="https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-electronic-trading-platforms-recommendation.pdf">https://www.sec.gov/spotlight/fixed-income-advisory-committee/fimsac-electronic-trading-platforms-recommendation.pdf</a>
(expressing concern about regulatory harmonization among fixed
income trading platforms, recognizing that some firms were regulated
as ATSs, while some were regulated as broker-dealers or not
regulated at all).
\67\ See infra Section II.D.1.
\68\ See infra Section II.D.2.
\69\ See infra Section II.D.
\70\ See infra Section VIII.C.3.a.
\71\ See supra Section II.A.
\72\ The Commission is not proposing to amend Exchange Act Rule
3b-16(b), which excludes from the definition of ``exchange'' systems
that perform only traditional broker-dealer activities, including:
Systems that route orders to a national securities exchange, a
market operated by a national securities association, a broker-
dealer for execution, or systems that allow persons to enter orders
for execution against the bids and offers of a single dealer if
certain additional conditions are met. These systems would continue
to not fall within the definition of ``exchange.'' As discussed
below, and consistent with the Commission's views expressed in the
Regulation ATS Adopting Release, a broker-dealer's exercise of
discretion and judgment over its customers' orders or trading
interest does not make the broker-dealer an exchange. See Regulation
ATS Adopting Release, supra note 31, at 70851. See also infra
Section II.C.3. The Commission is proposing to add an exclusion to
Rule 3b-16(a) for systems that allow issuers to sell their own
securities to investors. See infra Section II.C.2. Further, as
explained below, the Commission is not proposing to include within
the definition of ``exchange'' a system that unilaterally displays
trading interest without offering a trading facility or
communication protocols to bring together buyers and sellers. Also,
systems that provide general connectivity for persons to communicate
without protocols, such as utilities or electronic web chat
providers, would not fall within the definition of exchange. See id.
---------------------------------------------------------------------------
Including Communication Protocol Systems within the definition of
``exchange'' would provide market participants that use these market
places with the investor protections, fair and orderly market
principles, and Commission oversight provided by the exchange
regulatory framework.\73\ A Communication Protocol System that chooses
to register as an exchange would be an SRO and be subject to the
requirements of Section 6 of the Exchange Act, as discussed further
below.\74\ However, the Commission expects that many Communication
Protocol Systems would choose instead to comply with the conditions of
the Regulation ATS exemption, which includes registering as a broker-
dealer.\75\ As discussed further below, Communication Protocol Systems
complying with Regulation ATS would also be subject to the Regulation
ATS investor protection provisions, including the requirement to
establish written safeguards and procedures to protect confidential
subscriber trading information \76\ and operational transparency
requirements of Form ATS-N for ATSs that trade NMS stocks or government
securities or repos.\77\ They would also be subject to fair and orderly
markets provisions under the Fair Access Rule.\78\ Registering as a
broker-dealer would subject a Communication Protocol System to
Commission and Financial Industry Regulatory Authority (``FINRA'')
oversight.\79\ As a FINRA member, the Communication Protocol System
would be subject to FINRA's investor protection and examination and
market surveillance programs and would be required to comply with
FINRA's trade reporting rules.
---------------------------------------------------------------------------
\73\ See infra Section II.D.
\74\ See infra Section II.D.1.
\75\ See infra Section II.D.2.
\76\ See infra note 170 and accompanying text.
\77\ See infra notes 139-142 and accompanying text. A
Communication Protocol System that operates as an ATS but trades
securities other than NMS stocks or government securities would file
Form ATS.
\78\ See infra notes 154-155 and accompanying text.
\79\ See infra notes 131-133 and accompanying text.
---------------------------------------------------------------------------
The proposal to include Communication Protocol Systems within the
definition of exchange would promote competition by reducing cost
disparities and creating a more level competitive landscape.\80\
Several commenters in response to the Concept
[[Page 15503]]
Release expressed concerns regarding the disparity in regulatory
treatment between exchanges, ATSs, and other fixed income
platforms.\81\ In addition, FIMSAC expressed concern about the lack of
regulatory harmonization among fixed income electronic trading
platforms, recognizing that some firms are regulated as ATSs, while
others are regulated as broker-dealers or not at all, and stated that
these distinctions in regulatory oversight complicate efforts to
improve the efficiency and resiliency of the fixed income electronic
trading markets.\82\ In response to the Concept Release, one commenter
stated that the current regulatory framework puts ATSs at a competitive
disadvantage to non-ATS trading platforms, which are not subject to the
same regulatory obligations designed to protect investors and the
integrity of the fixed income markets.\83\ Another commenter stated its
belief that disparate regulatory treatment across trading platforms
impacts market efficiency and competition and introduces potential
resiliency risks.\84\ Another commenter stated that electronic
platforms for bringing together buyers and sellers of fixed income
securities for the purpose of effecting transactions should generally
be regulated the same regardless of how they are structured
internally.\85\ The Commission recognizes that the regulatory costs
associated with registering and operating as a registered exchange are
higher than the regulatory costs associated with registering as a
broker-dealer and complying with Regulation ATS. However, Communication
Protocol Systems operating outside the exchange regulatory framework
are subject to neither national securities exchange nor ATS regulatory
costs and therefore have an advantage when competing against other
markets that also bring together buyers and sellers of securities.\86\
As discussed further in Section VIII, a trading system that performs an
exchange market function but is not subject to the exchange regulatory
regime could receive a competitive advantage because such systems are
not subject to the compliance costs to which regulated exchanges are
subject.
---------------------------------------------------------------------------
\80\ See infra Section VIII.C.3.a.
\81\ See, e.g., ICE Bonds Letter II at 2-4; Citadel Letter at 2;
MFA Letter at 6 (suggesting that to ensure that similarly situated
entities are treated similarly in the trading of government
securities, the Commission should review the appropriateness of
similar regulation on multiple-to-multiple trading venues with
significant volume); MarketAxess Letter at 1 (stating that there
should be a common regulatory framework for all multilateral fixed
income electronic trading platforms that requires minimum standards
of conduct and oversight in areas such as trade reporting,
resiliency, cyber-security, operational reporting, financial
standards, examination, surveillance, and confidentiality).
\82\ See supra note 66. The FIMSAC concerns were highlighted by
the Commission in the Concept Release.
\83\ See ICE Bonds Letter II at 4 (stating that the benefits of
subjecting non-ATS trading platforms to the same regulatory
obligations as current ATSs will be substantial).
\84\ See FIA PTG Letter at 2. See also Citadel Letter at 2
(stating that excluding multilateral RFQ platforms from the current
regulatory framework creates an unlevel regulatory field).
\85\ See letter from Michael Decker, Senior Vice President for
Public Policy, Bond Dealers of America, dated March 1, 2021 (``BDA
Letter'') at 2. See also FINRA Letter at 6-10 (noting inconsistent
regulatory treatment among electronic and hybrid fixed income
trading platforms, as well as potential regulatory gaps, flowing in
part from the definitions and guidance adopted in 1998 in Regulation
ATS). The commenter stated its belief that it would be beneficial
for the Commission to provide guidance that specifically addresses
the characteristics of RFQ trading systems and evaluate whether they
meet the ``exchange'' definition for purposes of Regulation ATS.
\86\ See infra Section VIII.C.3.a.i.
---------------------------------------------------------------------------
Amending Exchange Act Rule 3b-16(a) to include non-firm trading
interest would eliminate the possibility that systems may offer the use
of non-firm trading interest that, in practice, functions as firm
orders, so as to avoid exchange registration or complying with
Regulation ATS. In the Regulation ATS Adopting Release, the Commission
expressed concern that system providers may label trading interest that
is firm in practice as non-firm.\87\ The providers of such systems may
take the position that their systems arguably do not use ``orders'' and
thus do not fall within the criteria of Rule 3b-16. For example,
systems that offer the use of non-firm trading interest may monitor
participants' firm-up rates in response to a quote they received and
may penalize a participant with a low firm-up rate either economically
or by limiting its ability to use features of its system. Such
activities could cause participants on the systems to believe that
trading interest that they submit or receive is effectively firm and
affect their behavior on the system. The difference between what is a
firm order and what is not requires careful scrutiny of the design of
the system, the trading interest offered, and what actually takes place
among buyers and sellers interacting on the systems. The Commission
believes, however, that the use of firm or non-firm trading interest by
a system should no longer be a factor in determining whether a system
performs the function of a market place because both firm and non-firm
trading interest can be used by a system with the same purpose and
effect to bring together buyers and sellers of securities.\88\
---------------------------------------------------------------------------
\87\ See Regulation ATS Adopting Release, supra note 31, at
70850.
\88\ See supra Section II.B.2.
---------------------------------------------------------------------------
Finally, for clarity, Exchange Act Rule 3b-16(a) would continue to
encompass systems that make available for trading any type of security.
The definition of ``exchange'' under Section 3(a)(1) of the Exchange
Act and current Exchange Act Rule 3b-16(a) applies to all securities,
including government securities, corporate bonds, municipal securities,
NMS stocks, equity securities that are not NMS stocks, private
restricted securities, repurchase agreements and reverse repurchase
agreements, foreign sovereign debt, and options, and does not exempt or
exclude any security or type of securities. The Commission believes
that it is important for any system that falls within the criteria of
Rule 3b-16(a) to be subject to the exchange regulatory framework,
notwithstanding how thinly traded or novel a security may be, and
participants on such systems should be able to avail themselves of the
same benefits that participants on registered exchanges or ATSs
receive. Accordingly, the proposed amendments to Rule 3b-16(a) do not
change the Commission's interpretation of the statutory definition of
``exchange''--that is, it applies to all securities.
The Commission received several comments in response to the Concept
Release expressing reservations about revising Exchange Act Rule 3b-16
to include certain fixed income markets within the definition of
exchange. One commenter stated that doing so would insert unnecessary
intermediation between dealers and their customers and threaten to
distort the market structure by creating a one-size-fits-all approach
that is biased against the trading of less-liquid instruments, damaging
liquidity formation.\89\ Another commenter expressed concern about the
Commission creating additional regulatory obligations in the fixed
income space and believed the Commission should undertake a more in-
depth review of fixed income trading, engage in discussion with the
industry, and outline the problems that any proposed regulations are
intended to solve before moving forward with any such regulatory
proposal.\90\ Likewise, another commenter stated its belief that the
Commission should not impose
[[Page 15504]]
Regulation ATS and the current exchange framework on existing and
emerging electronic trading protocols and functionalities that do not
meet the existing definition of an ATS or an exchange \91\ because such
rules are better suited for regulating systems and trading practices in
the equity markets.\92\ In addition, one commenter stated that there
are a variety of trading protocols that have developed within the fixed
income market--such as those that are primarily order-driven (such as
retail-focused order books) and others that are driven by price
requests (such as RFQs)--and that the market continues to innovate.\93\
This commenter stated its belief that the Commission should take into
account these distinctions and apply a lighter regulatory approach in
order to avoid stifling innovation.\94\
---------------------------------------------------------------------------
\89\ See Bloomberg Letter at 17-20. This commenter specifically
cited RFQs as a new protocol that has helped in discovering less
liquid instruments.
\90\ See SIFMA Letter at 11. The commenter stated its belief
that systems that merely act as informational conduits should remain
outside the scope of Regulation ATS.
\91\ See ICI Letter at 2, 7. This commenter stated that, for
example, tools that facilitate trade-related communications between
market participants should not be subject to rules that are better-
suited for order book protocols.
\92\ See id. at 8.
\93\ See MarketAxess Letter at 2-4.
\94\ See id.
---------------------------------------------------------------------------
The Commission notes that these comments focused on the fixed
income market exclusively. However, these comments have aided in the
formulation of this proposal for revising the Commission interpretation
of the definition of ``exchange,'' and the Commission looks forward to
receiving more comments to aid in its deliberations. As a preliminary
response to the comment letters summarized in this section, the
Commission does not believe that the proposed amendments to Exchange
Act Rule 3b-16 would create a one-size-fits-all model, imposing
unnecessary intermediation between dealers and their customers,\95\ or
import concepts from the equity markets onto emerging electronic
trading protocols that would damage the market structure in the fixed
income markets.\96\ Form ATS and Form ATS-N do not impose or favor any
specific market structure or manner of trading, and the Commission is
proposing to amend Form ATS-N to accommodate the operations of
Communication Protocol Systems. Further, the Commission preliminarily
does not believe that regulating fixed income systems, or systems for
other asset classes of securities, under the exchange regulatory
framework, particularly Regulation ATS, would stifle innovation or be
biased against less-liquid instruments using an RFQ protocol.
Regulation ATS is designed to be flexible enough to accommodate the
evolving technology of ATSs and allow for systems to continue to
innovate without the regulatory obligations of registered exchanges,
which are SROs.\97\ In the years since its adoption in 1998, many
systems that chose to operate under the Regulation ATS exemption have
had varied business models, including offering RFQ protocols as part of
their overall ATS services, for trading different types of securities,
including, among others, government securities, corporate bonds,
municipal securities, NMS stocks, equity securities that are not NMS
stocks, private restricted securities, repurchase agreements and
reverse repurchase agreements, foreign sovereign debt, and options.
---------------------------------------------------------------------------
\95\ See Bloomberg Letter at 17-20.
\96\ See ICI Letter at 8.
\97\ See Regulation ATS Adopting Release, supra note 31, at
70846.
---------------------------------------------------------------------------
The Commission seeks public comment on all aspects its proposal to
amend Exchange Act Rule 3b-16(a), the Communication Protocol Systems
that would fall within the definition of ``exchange,'' and the existing
exchange regulatory requirements that would apply to a Communication
Protocol System.
C. Proposed Amendments to Exchange Act Rule 3b-16
Today, Exchange Act Rule 3b-16 provides that an organization,
association, or group of persons meets the definition of ``exchange''
if it doesn't meet one of the exceptions of the rule and it: (1) Brings
together the orders for securities of multiple buyers and sellers; and
(2) uses established, non-discretionary methods (whether by providing a
trading facility or by setting rules) under which such orders interact
with each other, and the buyers and sellers entering such orders agree
to the terms of the trade.
The Commission is proposing to amend Exchange Act Rule 3b-16 to,
among other things, include non-firm indications of a willingness to
buy or sell a security, in addition to orders, within the
interpretation, define ``trading interest,'' add ``communication
protocols'' as an established method that an organization, association,
or group of persons can provide to bring together buyers and sellers of
securities, simplify and align the rule text with the statutory
definition of exchange under Section 3(a)(1) of the Exchange Act, and
add an exclusion under Exchange Act Rule 3b-16(b). Accordingly, the
Commission is proposing to amend Exchange Act Rule 3b-16 to provide
that an organization, association, or group of persons would be
considered to constitute, maintain, or provide an exchange if it is not
subject to an exception under Rule 3b-16(b) and it: (1) Brings together
buyers and sellers of securities using trading interest; and (2) makes
available established, non-discretionary methods (whether by providing
a trading facility or communication protocols, or by setting rules)
under which buyers and sellers can interact and agree to the terms of a
trade.
1. Trading Interest; Brings Together Buyers and Sellers
The Commission is proposing to add a definition of the term
``trading interest'' to Exchange Act Rule 3b-16 and amend the rule to
replace ``orders'' with ``trading interest.'' The definition of trading
interest would allow for clear and consistent application of the
revised functional test for ``exchange'' under Rule 3b-16.
Under the proposal, Exchange Act Rule 3b-16(a) would continue to
apply to systems that use orders, as that term is currently defined and
applied in Rule 3b-16(c), to bring together buyers and sellers because
the term ``orders'' would be included in the definition of ``trading
interest.'' ``Trading interest,'' as proposed, would include
``orders,'' as the term is defined under Rule 3b-16(c), or any non-firm
indication of a willingness to buy or sell a security that identifies
at least the security and either quantity, direction (buy or sell), or
price.\98\ Based on Commission staff experience, generally, trading
systems have offered non-firm trading interest that included the symbol
and one of the following: Quantity, direction, or price. For example, a
message that is sent to system participants for an NMS stock that only
identifies the NMS stock symbol and quantity that the participant seeks
to trade would be considered trading interest. A message sent by a
participant of a corporate bond system to five potential counterparties
that only identifies the CUSIP for a bond and an instruction to buy
would be considered trading interest, as proposed, because it contains
the symbol and direction. If the same initiating participant only
provided the symbol and requested a two-sided quote in response, the
response would constitute trading interest as it would identify the
symbol
[[Page 15505]]
and a price. Indeed, Commission staff has observed that ATSs that offer
a negotiation functionality to bring together buyers and sellers offer
the use of non-firm trading interest that includes the symbol and one
of the following: Quantity, direction, or price. In addition, there are
instances where systems offer the use of non-firm trading interest,
such as an indication of interest, that includes the symbol and
direction but does not explicitly include a quantity or price, which
can be inferred from the facts and circumstances accompanying the
trading interest.\99\ The Commission believes that a system that offers
the use of a message that identifies the security and either the
quantity, direction, or price would provide sufficient information to
bring together buyers and sellers of securities because it allows a
market participant to communicate its intent to trade and a reasonable
person receiving the information to decide whether to trade or engage
in further communications with the sender.\100\
---------------------------------------------------------------------------
\98\ In conjunction with adding the defined term ``trading
interest'' to Rule 3b-16, the Commission is proposing to add the
definition of ``trading interest'' to Rule 300 of Regulation ATS.
See proposed Rule 300(q). In addition, to encompass persons who
transact in trading interest, and not only orders, the Commission is
also proposing to change the definition of ``Subscriber'' in Rule
300(b) to include any person submitting, disseminating, or
displaying ``trading interest.'' See Rule 300(b), as proposed to be
revised.
\99\ See Regulation ATS Adopting Release, supra note 31, at
70850.
\100\ A system that uses trading interest to bring together
buyers and sellers would not meet the definition of ``exchange,''
however, unless it also met all the elements of Rule 3b-16(a),
including the element ``makes available established, non-
discretionary methods (whether by providing a trading facility or
communication protocols, or by setting rules) under which buyers and
sellers can interact and agree to the terms of a trade.''
---------------------------------------------------------------------------
On the other hand, the Commission preliminarily believes that a
message that only indicates the security to be traded without more
information would not be trading interest and a system that only offers
the use of such messages would be unlikely to bring together buyers and
sellers and does not warrant the regulatory oversight accompanying
classification as an exchange. Nevertheless, if a system is designed to
permit an initiating participant to submit a message that only contains
a symbol, yet a responding participant can submit a message that
contains a symbol and either quantity, direction, or price that the
initiator can accept, the message by the responding participant and
acceptance by the initiator would be trading interest because each of
these contain the symbol and at least direction, size, or price. As
proposed, the revised criteria of Exchange Act Rule 3b-16(a) that
include ``trading interest,'' as defined herein, would capture the vast
majority of systems that bring together buyers and sellers to agree to
the terms of a trade despite not including systems where solely the
security is identified. If adopted, however, the Commission would
continue to monitor market developments to ascertain whether such
systems may warrant further regulation in the future.
The Commission is also proposing to amend Rule 3b-16(a)(1) to
change the reference to a system that ``brings together the orders'' to
``brings together buyers and sellers of securities using trading
interest.'' Systems that use non-firm trading interest allow
participants to communicate their trading intentions, either on a
bilateral or multilateral basis, to negotiate a trade. Unlike orders,
non-firm trading interest typically does not interact with other non-
firm trading interest without further action by the potential
counterparties. Rather, the potential counterparties submitting non-
firm trading interest interact with each other through the use of
communication protocols. To provide for the use of both firm order
interaction and participants' interaction through non-firm trading
interest, the Commission is proposing to amend Rule 3b-16(a) to replace
``brings together orders'' with ``brings together buyers and sellers of
securities using trading interest.'' The phrase ``brings together
buyers and sellers of securities using trading interest'' still
captures systems that use orders. The Commission is not proposing to
change the meaning of ``to bring together'' as defined in the
Regulation ATS Adopting Release \101\ nor is the Commission proposing
to exclude from Rule 3b-16(a) systems that use orders to bring together
buyers and sellers of securities--such systems would still be subject
to Rule 3b-16.
---------------------------------------------------------------------------
\101\ See id. at 70849.
---------------------------------------------------------------------------
The Commission is proposing to amend Exchange Act Rule 3b-16(a)(2)
to simplify the rule text and align the rule text with the proposed
changes to Rule 3b-16(a)(1). Specifically, the Commission is proposing
to replace ``under which such orders interact with each other and the
buyers and sellers entering such orders agree to the terms of a trade''
with ``under which buyers and sellers can interact and agree to the
terms of a trade.'' As explained above, because the Commission is
proposing to amend Rule 3b-16(a) to include trading interest, and is no
longer limiting the application of the rule to orders, the focus on
``interaction'' should be between buyers and sellers rather than
orders. For similar reasons, the Commission is proposing to delete from
the rule text the phrase ``the buyers and sellers entering such
orders.'' This proposed change is designed to simplify the rule text
and remove the reference to orders because the proposed amendments to
Rule 3b-16(a) also include non-firm trading interest in addition to
orders.
2. Multiple; Exclusion for Issuer Systems
The Commission is proposing to remove the reference to securities
of ``multiple'' buyers and sellers from Exchange Act Rule 3b-16(a)(1)
and is proposing to codify in Rule 3b-16(b)(3) an example the
Commission provided in the Regulation ATS Adopting Release for systems
that allow issuers to sell their own securities to investors. These
proposed changes are not intended to change the existing scope of Rule
3b-16(a) but only to clarify its application.
The term ``multiple'' was added to Rule 3b-16(a) to help reinforce
that single counterparty systems were not included in the definition of
``exchange.'' \102\ These systems primarily included systems used by
issuers to sell their own securities and systems used by market makers
registered with an SRO, which are currently specifically excluded from
Rule 3b-16(a) under Rule 3b-16(b)(2). The Commission believes that the
term ``multiple'' could be misconstrued to mean that RFQ systems, for
example, do not meet the criteria of Rule 3b-16(a) because a
transaction request typically involves one buyer and multiple sellers
or one seller and multiple buyers.\103\
---------------------------------------------------------------------------
\102\ See id.
\103\ One commenter on the 2020 Proposal and Concept Release
stated its belief that RFQ platforms do not meet the criteria of
Rule 3b-16 because such platforms do not offer ``multiple-to-
multiple'' order interaction among participants and that the RFQ
platforms instead facilitate trading between an individual market
participant (requester) and potential liquidity providers
(responders). See ICI Letter at 2, 7.
---------------------------------------------------------------------------
Under current Rule 3b-16(a), whether a system meets the
``multiple'' prong depends on whether the system, when viewed in its
entirety, includes more than one buyer and more than one seller and is
not determined on a transaction-by-transaction basis. A system, such as
an RFQ system, that is designed to provide the ability of more than one
buyer to request quotes from more than one seller in securities at the
same or different times would meet the ``multiple'' prong of Rule 3b-
16(a) because such systems do not include a single counterparty.\104\
Because RFQ systems have more than one buyer and more than one seller,
such systems do not have a single counterparty and thus
[[Page 15506]]
would meet the standard of ``multiple buyers and sellers'' under Rule
3b-16(a)(1). Nevertheless, removing the term ``multiple'' would
mitigate confusion and the potential to misconstrue the application of
Rule 3b-16(a) to systems with non-firm trading interest, including RFQ
systems, and aligns the rule with the statutory definition of
``exchange.'' \105\
---------------------------------------------------------------------------
\104\ The mere interpositioning of a designated counterparty to
provide for the anonymity of counterparties to a trade or for
settlement purposes after the purchasing and selling counterparties
to a trade have been matched would not, by itself, mean the system
does not have multiple buyers and sellers. See Regulation ATS
Adopting Release, supra note 31, at 70849.
\105\ The use of plural terms in ``buyers and sellers'' in Rule
3b-16(a) and ``purchasers and sellers'' (emphasis added) in the
statutory definition of ``exchange'' makes sufficiently clear that
an exchange need only have more than one buyer and more than one
seller participating on the system to meet this prong.
---------------------------------------------------------------------------
The Commission is proposing to amend Rule 3b-16(b) to add an
exclusion from Rule 3b-16(a) for systems that allow an issuer to sell
its securities to investors. The Commission stated in the Regulation
ATS Adopting Release that systems for issuers to sell their own
securities would not fall within Rule 3b-16(a) because such systems
have a single counterparty that is selling its securities.\106\ The
Commission continues to believe that such systems do not meet the
criteria of Rule 3b-16(a) because the systems do not bring together
multiple buyers and multiple sellers. Given the proposal to remove the
term ``multiple'' from Rule 3b-16(a)(1), adding the exclusion for
issuer systems would clarify that such systems do not fall within the
criteria of Rule 3b-16(a).
---------------------------------------------------------------------------
\106\ See supra note 102 and accompanying text.
---------------------------------------------------------------------------
3. Established Methods; Communication Protocols
The Commission is proposing to amend Rule 3b-16(a)(2) to replace
``uses established, non-discretionary methods'' with the phrase ``makes
available established, non-discretionary methods.'' The proposed change
to use the word ``makes available'' rather than ``uses'' is designed to
capture established, non-discretionary methods that an organization,
association, or group of persons may provide, whether directly or
indirectly, for buyers and sellers to interact and agree upon terms of
a trade. In contrast to the term ``uses,'' the Commission believes the
term ``makes available'' would be applicable to Communication Protocol
Systems because such systems take a more passive role in providing to
their participants the means and protocols to interact, negotiate, and
come to an agreement.
The term ``makes available'' is also intended to make clear that,
in the event that a party other than the organization, association, or
group of persons performs a function of the exchange, the function
performed by that party would still be captured for purposes of
determining the scope of the exchange under Exchange Act Rule 3b-16. In
the Regulation ATS Adopting Release, the Commission stated that it will
attribute the activities of a trading facility to a system if that
facility is offered by the system directly or indirectly (such as where
a system arranges for a third party or parties to offer the trading
facility).\107\ The Commission has further recognized how a system may
consist of various functionalities, mechanisms, or protocols that
operate collectively to bring together the orders for securities of
multiple buyers and sellers using non-discretionary methods under the
criteria of Rule 3b-16(a), and how, in some circumstances, these
various functionalities, mechanisms, or protocols may be offered or
performed by another business unit of the registered broker-dealer or
government securities broker or government securities dealer that
operates the ATS (``broker-dealer operator'') or by a separate
entity.\108\ These principles equally apply to an organization,
association, or group of persons that arranges with another party to
provide, for example, a trading facility or communication protocols, or
parts thereof, to bring together buyers and sellers and perform a
function of a system under Rule 3b-16. Using the term ``makes
available'' will help ensure that the investor protection and fair and
orderly markets provisions of the exchange regulatory framework apply
to all the activities that consist of the system that meets the
criteria of Rule 3b-16(a), notwithstanding whether those activities are
performed by a party other than the organization that is providing the
market place.\109\
---------------------------------------------------------------------------
\107\ See Regulation ATS Adopting Release, supra note 31, at
70852.
\108\ See NMS Stock ATS Adopting Release, supra note 2, at 38844
(citing Regulation ATS Adopting Release, 63 FR 70852).
\109\ Depending on the activities of the persons involved with
the market place, a group of persons, who may each perform a part of
the 3b-16 system, can together provide, constitute, or maintain a
market place or facilities for bringing together purchasers and
sellers of securities and together meet the definition of exchange.
In such a case, the group of persons would have the regulatory
responsibility for the exchange.
---------------------------------------------------------------------------
The Commission is not proposing to delete the term ``non-
discretionary'' from Rule 3b-16(a)(2). The term ``non-discretionary''
was added to Rule 3b-16(a)(2) to modify ``methods'' to distinguish the
activities of an exchange from the activities of a broker-dealer.\110\
As discussed in the Regulation ATS Adopting Release, broker-dealers
exercise control, judgement, or discretion over their customers' orders
or trading interests \111\ while an exchange operates pursuant to
programmed procedures or set rules and does not exercise discretion
over orders or trading interest entered into the system.\112\ The
Commission continues to believe that the distinction between an
exchange and a broker-dealer explained in the Regulation ATS Adopting
Release is appropriate and the Commission is not proposing to amend
Exchange Act Rule 3b-16(a) to include activities of broker-dealers
within the definition of ``exchange.'' \113\
---------------------------------------------------------------------------
\110\ See Regulation ATS Adopting Release, supra note 31, at
70863.
\111\ See id. at 70851.
\112\ See id. at 70850.
\113\ If a system meets the criteria of Exchange Act Rule 3b-
16(a) but includes in that system the ability of the system operator
to apply its discretion for handling trading interest, these
activities employing discretion by the system operator would be
included in the system that meets the criteria of Rule 3b-16(a) and
be subject to Federal securities laws and rules applicable to a
registered exchange or ATS (including, for example, requirements to
provide disclosures about the system operator's activities on Form
ATS or ATS-N and, if the ATS is subject to the Fair Access Rule,
include in its written standards why the activities of the system
operator that result in the different treatment of subscribers are
fair and not unreasonably discriminatory).
---------------------------------------------------------------------------
The term ``non-discretionary'' should not be misconstrued to mean
that a system does not meet the definition of exchange if it permits
buyers or sellers using the system to exercise discretion with regard
to the use of the system. Under current Rule 3b-16(a)(2), the phrase
``uses established, non-discretionary methods'' applies to the
organization, association, or group of persons that provides the
means--the trading facility or rules--under which orders interact.
Thus, an organization that meets the definition of ``exchange'' does
not exercise any discretion in the matching of buyers and sellers or
their orders and buyers and sellers participating on an exchange can
use their own discretion in finding and selecting a counterparty.\114\
The phrase
[[Page 15507]]
``established, non-discretionary methods'' continues to convey that the
system provider is providing the trading facility or communication
protocols or setting rules and is not applying its discretion in
matching counterparties on the system.\115\
---------------------------------------------------------------------------
\114\ One commenter on the 2020 Proposal and Concept Release
stated their belief that ``unlike an ATS on which trading takes
place on a non-discretionary basis, trading discretion is a defining
feature of these protocols; a requesting participant can choose the
number and identity of participants that will receive the RFQ, while
participants who receive an RFQ can choose whether to respond.'' See
ICI Letter at 7. See also Bloomberg Letter at 23 (describing that an
RFQ ``consists of discretionary directed order communication network
messaging'' and stating its belief that such messaging is not an ATS
function because RFQs lack a non-discretionary commitment to trade)
and MarketAxess Letter at n.2 (stating its belief that an RFQ
trading requestor's trading discretion puts the protocol outside the
requirement that the platform use ``established, non-discretionary
methods under which such orders interact with each other''). The
``established, non-discretionary methods'' element of Rule 3b-
16(a)(2) pertains to the discretion applied by the system provider
to bring together buyers and sellers and not discretion that
participants may apply. For example, a system provider that matches
buyers and sellers using its judgement or discretion would not be
using established, non-discretionary methods. As the Commission
stated in the Regulation ATS Adopting Release, where customers of a
broker-dealer exercise control over their own orders in a trading
system operated by the broker-dealer, that broker-dealer is unlikely
to be viewed as using discretionary methods in handling the order.
See Regulation ATS Adopting Release, supra note 31, at 70851.
\115\ See id. (describing that, for example, the Commission does
not believe that block trading desks, which generally retain some
discretion in determining how to execute a customer's order, and
frequently commit capital to satisfy their customers' needs, use
established, non-discretionary methods).
---------------------------------------------------------------------------
The Commission is proposing to amend Rule 3b-16(a)(2) to add
``communication protocols'' as an established method that an
organization, association, or group of persons can provide to bring
together buyers and sellers of securities. Systems that bring together
buyers and sellers of securities may function as exchange market places
of securities without orders or a trading facility for orders to
interact. In the Commission's experience, communication protocols,
which can be applied to various technologies and connectivity,
generally use non-firm trading interest as opposed to orders to prompt
and guide buyers and sellers to communicate, negotiate, and agree to
the terms of the trade. For example, if an entity makes available a
chat feature, which requires certain information to be included in a
chat message (e.g., price, quantity) and sets parameters and structure
designed for participants to communicate about buying or selling
securities, the system would have established communication protocols.
While Communication Protocol Systems may not match counterparties'
trading interest, buyers and sellers using these can be brought
together to interact, either on a bilateral or multilateral basis, and
agree upon the terms of the trade. Protocols that a system offers may
take many forms and could include: Setting minimum criteria for what
messages must contain; setting time periods under which buyers and
sellers must respond to messages; restricting the number of persons a
message can be sent to; limiting the types of securities about which
buyers and sellers can communicate; setting minimums on the size of the
trading interest to be negotiated; or organizing the presentation of
trading interest, whether firm or non-firm, to participants. These
examples are not exhaustive, and the determination of whether the
system meets Rule 3b-16(a)(2) would depend on the particular facts and
circumstances of each system. Nevertheless, as proposed, the Commission
would take an expansive view of what would constitute ``communication
protocols'' under this prong of Rule 3b-16(a).\116\
---------------------------------------------------------------------------
\116\ One commenter suggested a litmus test to assist the
Commission in determining whether a fixed-income trading platform
for corporate bonds and municipal securities meets the criteria that
warrant registration as an exchange or ATS. According to the
commenter, the most relevant criteria were: Whether the system
provides multilateral trading, whether the technology provider has
any influence on picking the counterparties, whether the system
enables any sharing of real-time information across multiple
counterparties, whether the system provider has any access to real-
time information, and whether the transactions happen on the
technology platform. See letter from Vijay Kedia, President and CEO,
FlexTrade Systems, dated March 1, 2021 (``FlexTrade Systems
Letter'') at 2. As discussed above, the Commission believes that
conditions have changed whereby systems that offer the use trading
interest and protocols to bring together buyers and sellers of
securities perform an exchange market place function similar to
systems that offer the use of orders and trading facilities. As
proposed, a Communication Protocol System can still meet the
criteria of Exchange Act Rule 3b-16 even if it has no role in
matching counterparties nor displays trading interest. In addition,
neither the current rule nor the proposed amendments require that,
for a system to be an exchange, an execution occur on the system;
rather, that the buyers and sellers agree to the terms of the trade
on the system is sufficient. See Regulation ATS Adopting Release,
supra note 31, at 70852 (stating ``whether or not the actual
execution of the order takes place on the system is not a
determining factor of whether the system falls under Rule 3b-16'').
Also, applying some of the criteria that the commenter suggested
(whether system provider have any access to real-time information;
whether the transactions happen on the technology platform) could
result in the exclusion of certain RFQ platforms from the definition
of exchange.
---------------------------------------------------------------------------
The Commission preliminarily believes that certain systems would
not fall within the criteria of Exchange Act Rule 3b-16(a), as proposed
to be amended, because the organization, association, or group of
persons would not be considered to be providing a trading facility or
communication protocol and therefore would not be considered to be
making available established, non-discretionary methods under Rule 3b-
16(a)(2).\117\ The Commission continues to believe that systems that
passively display trading interest, such as systems referred to in the
industry as bulletin boards, but do not provide means for buyers and
sellers to contact each other and agree to the terms of the trade on
the system would not be encompassed by Rule 3b-16(a) as proposed to be
amended.\118\ For example, the Commission does not believe that a
system that unilaterally displays trading interest without offering a
trading facility or communication protocols to bring together buyers
and sellers would be considered to be making available established,
non-discretionary methods.\119\ In the Regulation ATS Adopting Release,
the Commission stated that ``[u]nless a system also establishes rules
and operates a trading facility under which subscribers can agree to
the terms of their trades, the system will not be included within Rule
3b-16 even if it brings together `orders.' '' \120\ These systems may
display trading interest to potential buyers and sellers, but the
system provider is not making available established methods for buyers
and sellers to interact and agree upon terms of a trade. If adopted,
however, the Commission would continue to monitor market developments
to ascertain whether such systems may warrant further regulation in the
future.
---------------------------------------------------------------------------
\117\ To the extent that a system is currently operating
consistently with the circumstances described in a staff no-action
letter, a system that falls within the scope of Rule 3b-16(a) and
seeks to rely on the ATS exemption would need to register as a
broker-dealer to comply with the broker-dealer registration
requirement under Regulation ATS, regardless of any prior staff
statement. Upon the adoption of any final rule, some letters and
other staff statements, or portions thereof, may be moot,
superseded, or otherwise inconsistent with the final rule and,
therefore, would be withdrawn or modified.
\118\ See Regulation ATS Adopting Release, supra note 31, at
70850. See also FINRA Letter at 9-10 (requesting the Commission
provide additional guidance on the regulatory classification of
bulletin boards).
\119\ See SIFMA Letter at 11 (stating that systems that merely
act as informational conduits should remain outside the scope of
Regulation ATS); FlexTrade Systems Letter at 2-4 (stating that
software vendors that provide functionality for displaying prices do
not meet the definition of an exchange).
\120\ See Regulation ATS Adopting Release, supra note 31, at
70850.
---------------------------------------------------------------------------
Similarly, a system that displays trading interest and provides
only connectivity among participants without providing a trading
facility to match orders or providing protocols for participants to
communicate and interact would not meet the criteria of Rule 3b-16(a)
because such system would not be considered to be making available
established, non-discretionary methods. For example, systems that only
provide general connectivity for persons to communicate without
protocols, such as utilities or electronic web chat providers, would
not fall within the communication protocols prong of the proposed rule
because such providers are not specifically designed
[[Page 15508]]
to bring together buyers and seller of securities or provide procedures
or parameters for buyers and sellers for securities to interact. To the
extent that such systems are designed for securities and provide
communication protocols for buyers and sellers to interact and agree to
the terms of a trade, such systems would fall within the criteria of
Exchange Act Rule 3b-16(a) as proposed to be revised.
D. Exchange Registration or ATS Exemption for Communication Protocol
Systems Under the Proposed Rules
The proposed amendments to Exchange Act Rule 3b-16(a) would scope
Communication Protocol Systems into the definition of ``exchange,'' in
which case, the systems may decide between registering as a national
securities exchange or registering as a broker-dealer and complying
with Regulation ATS. The Commission believes that many Communication
Protocol Systems would likely choose to be regulated as an ATS because
of the lighter regulatory requirements imposed on them, as compared to
the regulatory requirements of registered exchanges, which are SROs.
Unlike a national securities exchange, an ATS can trade any type of
security and its users are not limited to broker-dealers. In addition,
an ATS is not an SRO, is not subject to Section 6 of the Exchange Act,
and does not require Commission approval for its activities. Complying
with Regulation ATS would therefore allow Communication Protocol
Systems more flexibility in the operation of their business than
registering as an exchange.\121\
---------------------------------------------------------------------------
\121\ ATSs have more flexibility in the operation of their
business than exchanges insofar as ATSs are not subject to Section 6
of the Exchange Act and are not required to comply with the
statutory standards with respect to unfair discrimination, burdens
on competition, and the equitable allocation of reasonable fees.
---------------------------------------------------------------------------
Further, many Communication Protocol Systems make available for
trading fixed income securities that are only traded over-the-counter
and are not typically registered and approved for listing on an
exchange.\122\ Unless a national securities exchange receives an
exemption to trade unregistered debt securities,\123\ it may only list
and trade registered debt securities, whereas Communication Protocol
Systems need not receive such an exemption to trade unregistered debt
securities. Notwithstanding, the Commission discusses the regulatory
requirements for both regulatory alternatives below. The Commission is
not proposing to make changes to the regulatory structure for exchanges
or the requirements for national securities exchanges. The proposed
changes to the regulatory requirements under Regulation ATS are
discussed in more detail below.\124\
---------------------------------------------------------------------------
\122\ Section 12(a) of the Exchange Act makes it unlawful for
any member, broker, or dealer to effect any transaction in any
security (other than an exempted security) on a national securities
exchange unless a registration statement has been filed with the
Commission and is in effect as to such security for such exchange in
accordance with the provisions of the Exchange Act and the rules and
regulations thereunder. 15 U.S.C. 78l(a). Section 12(b) of the
Exchange Act, 15 U.S.C. 78l(b), contains procedures for the
registration of securities on a national securities exchange.
Section 12(a) does not apply to an exchange that the Commission has
exempted from registration as a national securities exchange. See,
e.g., Securities Exchange Act Release No. 28899 (February 20, 1991),
56 FR 8377 (February 29, 1991). See also Regulation ATS Adopting
Release, supra note 31, at 70886.
\123\ See, e.g., Securities Exchange Act Release No. 54767
(November 16, 2006), 71 FR 67680 (November 22, 2006) (SR-NYSE-2004-
69) (issuing exemption permitting NYSE to trade unregistered debt
securities on its bonds platform, now known as NYSE Bonds).
\124\ See infra Section III.B.2 (discussing proposed changes to
Rule 301(b)(1) of Regulation ATS), Section IV (discussing proposed
changes to Rule 304 and Form ATS-N), Section V.A (discussing
proposed changes to Rule 301(b)(5) and 301(b)(6)), and Section V.C
(discussing proposed changes to Rule 301(b)(2)(vii)).
---------------------------------------------------------------------------
1. National Securities Exchange Registration
A Communication Protocol System that chooses to register as a
national securities exchange would be required to do so pursuant to
Sections 5 and 6 of the Exchange Act. A national securities exchange is
an SRO and must set standards of conduct for its members, administer
examinations for compliance with these standards, coordinate with other
SROs with respect to the dissemination of consolidated market data, and
generally take responsibility for enforcing its own rules and the
provisions of the Exchange Act and the rules and regulations
thereunder. Before a national securities exchange may commence
operations, the Commission must approve its application for
registration filed on Form 1.\125\ Section 6(b) of the Exchange Act
requires, among other things, that the national securities exchange be
so organized and have the capacity to carry out the purposes of the
Exchange Act and to comply and enforce compliance by its members, and
persons associated with its members, with the Federal securities laws
and the rules of the exchange.\126\ Pursuant to Section 6 of the
Exchange Act, national securities exchanges must establish rules that
generally: (1) Are designed to prevent fraud and manipulation, promote
just and equitable principles of trade, and protect investors and the
public interest; (2) provide for the equitable allocation of reasonable
fees; (3) do not permit unfair discrimination; (4) do not impose any
unnecessary or inappropriate burden on competition; and (5) with
limited exceptions, allow any broker-dealer to become a member.\127\
---------------------------------------------------------------------------
\125\ See 15 U.S.C. 78f.
\126\ See Section 6(b)(1) of the Exchange Act, 15 U.S.C.
78f(b)(1). The Commission must also find that the national
securities exchange has rules that meet certain criteria. See
generally Exchange Act Section 6(b)(2) through (10), 15 U.S.C.
78f(b)(2) through (10).
\127\ See Section 6(b) of the Exchange Act.
---------------------------------------------------------------------------
After approval of its application for registration, a national
securities exchange must file with the Commission any proposed changes
to its rules.\128\ The initial application on Form 1, amendments
thereto, and filings for proposed rule changes, in combination,
publicly disclose important information about national securities
exchanges, such as trading services and fees. The Commission's order
approving the application is also public. The Commission oversees the
exchanges under the Exchange Act through, among other things, its
examination authority under Section 17, its enforcement authority under
Sections 19(h)(1) and 21C, its authority to approve and disapprove
rules under Section 19(b), and its rulemaking authority under various
Exchange Act provisions. Under the Exchange Act, securities traded on a
national securities exchange must be registered with the Commission and
approved for listing on an exchange. National securities exchanges can
only have broker-dealer members. As an SRO, a national securities
exchange enjoys certain unique benefits, such as limited immunity from
private liability with respect to its regulatory functions and the
ability to receive consolidated revenue under the national market
system plans for equity market data (i.e., Consolidated Tape
Association (CTA)/Consolidated Quotation (CQ) and Unlisted Trading
Privilege (UTP)),\129\ among others.
---------------------------------------------------------------------------
\128\ See generally Section 19(b) of the Exchange Act, 15 U.S.C.
78s(b).
\129\ Details and the history of each plan can be found at
<a href="https://www.ctaplan.com/plans">https://www.ctaplan.com/plans</a>; and <a href="https://www.utpplan.com">https://www.utpplan.com</a>.
---------------------------------------------------------------------------
2. Regulation ATS Exemption; Broker-Dealer Registration
A Communication Protocol System may choose to operate as an ATS
pursuant to Regulation ATS, which exempts an ATS from the definition of
``exchange'' on the condition that the ATS is in compliance with the
requirements of Regulation ATS. An ATS that fails to comply with the
requirements of Regulation ATS would
[[Page 15509]]
no longer qualify for the ATS exemption and thus risks operating as an
unregistered exchange in violation of Section 5 of the Exchange Act.
To operate under the exemption, an ATS must register as a broker-
dealer under Exchange Act Section 15 or as a government securities
broker or government securities dealer under Exchange Act Section
15C(a)(1)(A),\130\ and comply with the filing and conduct obligations
associated with being a registered broker-dealer, including membership
in an SRO, such as FINRA,\131\ and compliance with the SRO's
rules.\132\ Requiring Communication Protocol Systems to register as
broker-dealers and be a member of an SRO would ensure that they are
subject to SRO examination and market surveillance, trade reporting
obligations, and certain investor protection rules. Broker-dealer
registration provides important investor protections under the Federal
securities laws and FINRA rules, such as: (1) Various disclosure and
supervision obligations; (2) anti-money laundering obligations
(including suspicious activity reporting); (3) FINRA over-the-counter
(OTC) trade reporting requirements, including requirements to maintain
membership in, or maintain an effective clearing arrangement with a
participant of, a clearing agency registered under the Exchange Act;
and (4) Commission examinations and FINRA examinations and surveillance
of members and markets that its members operate.
---------------------------------------------------------------------------
\130\ The Commission is proposing to amend Rule 301(b)(1) to
allow an ATS to register as a government securities broker or
government securities dealer under Exchange Act Section
15C(a)(1)(A). See infra notes 272-278 and accompanying text.
\131\ See Section 15(b)(8) of the Exchange Act; 15 U.S.C.
78o(b)(8).
\132\ See Regulation ATS Adopting Release, supra note 31, at
70903.
---------------------------------------------------------------------------
In addition, ATSs are subject to certain reporting and disclosure
requirements, as applicable. ATSs other than NMS Stock ATSs or, as
proposed, Government Securities ATSs, would be required, pursuant to
Rule 301(b)(2) of Regulation ATS, to file an initial operation report
with the Commission on Form ATS \133\ at least 20 days before
commencing operations or, in the case of Newly Designated ATSs,\134\ no
later than 30 calendar days after the effective date of any final
rule.\135\ Form ATS provides the Commission with the opportunity to
identify problems that might impact investors before the system begins
to operate.\136\ Unlike a Form 1 filed by a national securities
exchange, a Form ATS is not approved by the Commission.\137\ Also
unlike a Form 1 application, a Form ATS is deemed confidential when
filed.\138\ Requiring Communication Protocol Systems to file Form ATS
and amendments thereto will help the Commission monitor and oversee
such ATSs' operations.
---------------------------------------------------------------------------
\133\ Form ATS and the Form ATS Instructions are available at
<a href="https://www.sec.gov/about/forms/formats.pdf">https://www.sec.gov/about/forms/formats.pdf</a>. Form ATS would require,
among other things, that the ATS (other than a Government Securities
ATS or NMS Stock ATS) provide information about: Classes of
subscribers and differences in access to the services offered by the
ATS to different groups or classes of subscribers; securities the
ATS expects to trade; any entity other than the ATS involved in its
operations; the manner in which the system operates; how subscribers
access the trading system; procedures governing entry of trading
interest and execution; and trade reporting, clearance and
settlement of trades on the ATS. See infra Section V.B (describing
proposed changes to Form ATS). Regulation ATS provides that a report
on Form ATS or Form ATS-R shall be considered filed upon receipt by
the Division of Trading and Markets, at the Commission's principal
office in Washington, DC (i.e., in paper form), and that information
filed by an ATS on Form ATS is deemed confidential when filed. See
17 CFR 242.301(b)(2)(vii). See also infra Section V.C.
\134\ ``Newly Designated ATSs'' would be defined as ATSs
operating as of the effective date of any final rule that meet the
criteria under Rule 3b-16(a) as of the effective date of any final
rule but did not meet the criteria under Rule 3b-16(a) in effect
prior to the effective date of any final rule. See Rule 300(r).
\135\ See infra note 180 and accompanying text. The Commission
is also proposing changes to Rule 301(b)(2)(i) to clarify that the
requirement to file Form ATS does not apply to Covered ATSs or
Covered Newly Designated ATSs. See proposed Rule 301(b)(2)(i). See
also proposed Rule 300(s) (defining ``Covered Newly Designated
ATS'').
\136\ See Regulation ATS Adopting Release, supra note 31, at
70864.
\137\ Form ATS provides the Commission with notice about an
ATS's operations prior to commencing operations. An ATS is also
required to notify the Commission of any changes in its operations
by filing an amendment to its initial operation report. There are
three types of amendments to an initial operation report. First, if
any material change is made to its operations, the ATS must file an
amendment on Form ATS at least 20 calendar days before implementing
such change. See 17 CFR 242.301(b)(2)(ii). A ``material change,''
includes, but is not limited to, any change to the operating
platform, the types of securities traded, or the types of
subscribers. In addition, the Commission has stated that ATSs
implicitly make materiality decisions in determining when to notify
their subscribers of changes. See Regulation ATS Adopting Release,
supra note 31, at 70864. Second, if any information contained in the
initial operation report becomes inaccurate for any reason and has
not been previously reported to the Commission as an amendment on
Form ATS, the ATS must file an amendment on Form ATS correcting the
information within 30 calendar days after the end of the calendar
quarter in which the system has operated. See 17 CFR
242.301(b)(2)(iii). Third, an ATS must promptly file an amendment on
Form ATS correcting information that it previously reported on Form
ATS after discovery that any information was inaccurate when filed.
See 17 CFR 242.301(b)(2)(iv). An ATS is required to promptly file a
cessation of operations on Form ATS. See 17 CFR 242.301(b)(2)(v).
\138\ See 17 CFR 242.301(b)(2)(vii); Form ATS at 3, General
Instructions A.7.
---------------------------------------------------------------------------
NMS Stock ATSs and, as proposed, Government Securities ATSs, would
be subject to enhanced filing and disclosure requirements under Rule
304 of Regulation ATS. NMS Stock ATSs or Government Securities ATSs
would, in lieu of Form ATS, be required to file public Form ATS-N in
EDGAR, in which they must disclose detailed information about the
manner in which their trading systems operate and the potential for
conflicts of interest and information leakage.\139\ Form ATS-N is
subject to a Commission review and effectiveness process.\140\ An NMS
Stock ATS or Government Securities ATS would not be permitted to
operate pursuant to the Rule 3a1-1(a)(2) exemption until its Form ATS-N
has become effective.\141\ In addition, the ATS would be required to
file amendments on Form ATS-N to provide notice of changes to its
operations and broker-dealer and affiliate relationships.\142\ Form
ATS-N and the Commission review and effectiveness process, which is
described in detail below,\143\ would provide operational transparency
and regulatory oversight of Communication Protocol Systems that are NMS
Stock ATSs or Government Securities ATSs.
---------------------------------------------------------------------------
\139\ See proposed changes to 17 CFR 242.304.
\140\ See infra Section IV.A.
\141\ See Rule 304(a)(1)(i).
\142\ See infra Section IV.A.
\143\ See infra Section IV.
---------------------------------------------------------------------------
In addition, all ATSs are required to periodically, by paper
submission, report certain information about transactions in the ATS
and information about certain activities on Form ATS-R within 30
calendar days after the end of each calendar quarter in which the
market has operated, pursuant to Rule 301(b)(9).\144\ Form ATS-R
requires quarterly volume information for specified categories of
securities, as well as a list of all securities traded in the ATS
during the quarter and a list of all subscribers that were participants
during the quarter,\145\ and for ATSs subject to the Fair Access Rule
to provide certain additional
[[Page 15510]]
information.\146\ Like Form ATS, Rule 301(b)(2)(vii) and the
instructions to Form ATS-R provide that Form ATS-R is deemed
confidential when filed.\147\ The information reported on Form ATS-R by
Communication Protocol Systems would permit the Commission to monitor
the trading on these ATSs for compliance with the Exchange Act and
applicable rules thereunder and enforce the Fair Access Rule.\148\
---------------------------------------------------------------------------
\144\ See 17 CFR 242.301(b)(9)(i). Form ATS-R and the Form ATS-R
Instructions are available at <a href="https://www.sec.gov/about/forms/formats-r.pdf">https://www.sec.gov/about/forms/formats-r.pdf</a>. See also Section V.B (describing proposed changes to
Form ATS-R).
\145\ See Form ATS-R at 4, Items 1 and 2 (describing the
requirements for Exhibit A and Exhibit B of Form ATS-R). ATSs must
also complete and file Form ATS-R within 10 calendar days after
ceasing to operate. See 17 CFR 242.301(b)(9)(ii); Form ATS-R at 2,
General Instructions A.2 to Form ATS-R.
\146\ Form ATS-R also requires an ATS that is subject to the
fair access obligations under Rule 301(b)(5) of Regulation ATS to
provide a list of all persons granted, denied, or limited access to
the ATS during the period covered by the ATS-R and designate for
each person each of the following: Whether the person was granted,
denied, or limited access; the date the ATS took such action; the
effective date of such action; and the nature of any denial or
limitation of access. See Form ATS-R at 6, Item 7 (explaining
requirements for Exhibit C).
\147\ See 17 CFR 242.301(b)(2)(vii); Form ATS-R at 2, General
Instruction A.7.
\148\ See Regulation ATS Adopting Release, supra note 31, at
70874 and 70878.
---------------------------------------------------------------------------
NMS Stock ATSs must comply with certain order display and execution
access obligations \149\ under Rule 301(b)(3) if the ATS displays
subscriber orders in an NMS stock to any person (other than an employee
of the ATS) and meets certain volume requirements.\150\ These order
display and execution access obligations were adopted by the Commission
with the expectation they would promote additional market integration
and further discourage two-tier markets when trading in an NMS stock on
an ATS reaches a certain level.\151\ In addition, an NMS Stock ATS must
not charge any fee to broker-dealers that access the ATS through a
national securities exchange or national securities association that is
inconsistent with the equivalent access to the NMS Stock ATS that is
required under Rule 301(b)(3)(iii).\152\ This requirement is designed
to promote equal access to ATSs.
---------------------------------------------------------------------------
\149\ An ATS that displays orders and meets the volume
requirements must provide to a national securities exchange or
national securities association the prices and sizes of the orders
at the highest buy price and the lowest sell price for such NMS
stock, displayed to more than one person in the ATS, for inclusion
in the quotation data made available by the national securities
exchange or national securities association pursuant to Rule 602
under Regulation NMS. See 17 CFR 242.301(b)(3)(ii). With respect to
any such displayed order, the ATS must provide to any broker-dealer
that has access to the national securities exchange or national
securities association to which the ATS provides the prices and
sizes of displayed orders pursuant to Rule 301(b)(3)(ii), the
ability to effect a transaction with such orders that is equivalent
to the ability of such broker-dealer to effect a transaction with
other orders displayed on the exchange or by the association; and at
the price of the highest priced buy order or lowest priced sell
order displayed for the lesser of the cumulative size of such priced
orders entered therein at such price, or the size of the execution
sought by such broker-dealer. See 17 CFR 242.301(b)(3)(iii).
\150\ An ATS that displays subscriber orders in an NMS stock
must comply with Rule 301(b)(3) if, during at least four of the
preceding six calendar months, it had an average daily trading
volume of 5% or more of the aggregate average daily share volume for
that NMS stock, as reported by an effective transaction reporting
plan. See 17 CFR 242.301(b)(3)(i).
\151\ See Regulation ATS Adopting Release, supra note 31, at
70867.
\152\ See 17 CFR 242.301(b)(4). In addition, if the national
securities exchange or national securities association to which an
ATS provides the prices and sizes of orders under Rules
301(b)(3)(ii) and (iii) establishes rules designed to assure
consistency with standards for access to quotations displayed on
such national securities exchange, or the market operated by such
national securities association, the ATS shall not charge any fee to
members that is contrary to, that is not disclosed in the manner
required by, or that is inconsistent with any standard of equivalent
access established by such rules. See id.
---------------------------------------------------------------------------
As discussed in more detail below,\153\ ATSs are required to comply
with the Fair Access Rule \154\ under Rule 301(b)(5) if the ATS meets
volume thresholds in NMS stocks, equity securities that are not NMS
stocks and for which transactions are reported to an SRO, municipal
securities, or corporate debt securities.\155\ The Commission is
proposing to apply the requirements of the Fair Access Rule to trading
of U.S. Treasury Securities and Agency Securities on ATSs.\156\
---------------------------------------------------------------------------
\153\ See infra Section III.B.4 and Section V.A.
\154\ An ATS subject to the Fair Access Rule, as proposed to be
revised, must: Establish and apply reasonable written standards for
granting, limiting, and denying access to the services of the ATS;
make and keep records of all grants of access including, for all
participants, the reasons for granting such access, and all denials
or limitations of access and reasons, for each applicant and
participant, for denying or limiting access; and report on Form ATS-
R a list of persons granted, denied, and limited access to the ATS.
See infra Section V.A.
\155\ See 17 CFR 242.301(b)(5).
\156\ See infra Section III.B.4.
---------------------------------------------------------------------------
Additionally, under Rule 301(b)(6) (``Capacity, Integrity, and
Security Rule''), an ATS that trades only municipal securities or
corporate fixed income debt with 20% or more of the average daily
volume traded in the U.S. during at least four of the preceding six
calendar months would be required to comply with capacity, integrity,
and security standards \157\ with respect to those systems that support
order entry, order routing, order execution, transaction reporting, and
trade comparison.\158\ Information provided under the Capacity,
Integrity, and Security Rule would enable the Commission staff to
better understand the operation of certain Communication Protocol
Systems and to identify potential problems and trends that may require
attention.
---------------------------------------------------------------------------
\157\ An ATS that meets the volume requirements must, with
respect to those systems that support order entry, order routing,
order execution, transaction reporting, and trade comparison,
establish reasonable current and future capacity estimates; conduct
periodic capacity stress tests of critical systems to determine such
system's ability to process transactions in an accurate, timely, and
efficient manner; develop and implement reasonable procedures to
review and keep current its system development and testing
methodology; review the vulnerability of its systems and data center
computer operations to internal and external threats, physical
hazards, and natural disasters; establish adequate contingency and
disaster recovery plans; on an annual basis, perform an independent
review, in accordance with established audit procedures and
standards, of the ATS's controls for ensuring that the above
requirements are met, and conduct a review by senior management of a
report containing the recommendations and conclusions of the
independent review; and promptly notify the Commission and its staff
of material systems outages and significant systems changes. See 17
CFR 242.301(b)(6)(ii).
\158\ See 17 CFR 242.301(b)(6)(i).
---------------------------------------------------------------------------
NMS Stock ATSs, ATSs that trade non-NMS equity securities that are
reported to an SRO, and Government Securities ATSs that meet certain
trading thresholds would be subject to Regulation SCI. Regulation SCI
superseded and replaced Rule 301(b)(6) requirements with regard to ATSs
that trade NMS stocks and non-NMS stocks.\159\ The Commission is
proposing to apply Regulation SCI to Government Securities ATSs, as
discussed below.\160\ Regulation SCI is designed to help address the
technological vulnerabilities, and improve the Commission's oversight
of the core technology of key entities.
---------------------------------------------------------------------------
\159\ Regulation SCI does not apply to ATSs that trade only
municipal securities or corporate debt securities. See infra notes
351-356 and accompanying text. See also Regulation SCI Adopting
Release, supra note 3, at 72262.
\160\ See infra Section III.C.
---------------------------------------------------------------------------
All ATSs, regardless of the volume traded on their systems, are
required, pursuant to Rule 301(b)(7),\161\ to permit the examination
and inspection of their premises, systems, and records, and cooperate
with the examination, inspection, or investigation of subscribers,
whether such examination is being conducted by the Commission or by an
SRO of which such subscriber is a member. Because an ATS subscriber to
whom the Commission's inspection authority may not extend could use the
ATS to manipulate the market in a security, the requirement is designed
to require that ATSs cooperate in all inspections, examinations, and
investigations.
---------------------------------------------------------------------------
\161\ See 17 CFR 242.301(b)(7).
---------------------------------------------------------------------------
ATSs are also required, pursuant to Rule 301(b)(8),\162\ to make
and keep current the records specified in Rule 302 of Regulation ATS
\163\ and preserve
[[Page 15511]]
the records specified in 17 CFR 242.303.\164\ The Commission is
proposing to amend Rule 302 of Regulation ATS to require recordkeeping
related to ``trading interest.'' Rule 302 requires that an ATS shall
make and keep certain records, which the rule enumerates. Communication
Protocol Systems that choose to comply with Regulation ATS would be
required to keep the records enumerated in Rule 302. The Commission is
proposing to revise certain of these enumerated records that relate to
``orders'' to require such records related to ``trading interest,''
which would include both firm orders and non-firm trading
interest.\165\ This would include time-sequenced records of trading
interest information in the ATS.\166\ The recordkeeping requirements
would require Communication Protocol Systems to make and keep certain
records for an audit trail of trading activity that would allow the
Commission to detect and investigate potential market irregularities,
examine whether the ATS is in compliance with Federal securities laws,
and ensure investor protections.\167\
---------------------------------------------------------------------------
\162\ See 17 CFR 242.301(b)(8).
\163\ See 17 CFR 242.302. Rule 302 requires all ATSs to make and
keep current certain records, including: A record of subscribers to
the ATS; daily summaries of trading in the ATS; and time-sequenced
records of order information in the ATS. See 17 CFR 242.302.
\164\ See Rule 303 of Regulation ATS. In the Regulation ATS
Adopting Release, the Commission stated that these requirements to
make, keep, and preserve records are necessary to create a
meaningful audit trail and to permit surveillance and examination to
help ensure fair and orderly markets. See Regulation ATS Adopting
Release, supra note 31, at 70877-78.
\165\ See supra note 98 and accompanying text.
\166\ Specifically, the Commission is proposing to revise Rule
302(c)(1) (date and time (expressed in terms of hours, minutes, and
seconds) that the trading interest was received); (c)(3) (the number
of shares, or principal amount of bonds, to which the trading
interest applies); (c)(5) (the designation of the trading interest
as buy or sell trading interest); (c)(8) (any limit or stop price
prescribed by the trading interest); (c)(9) (the date on which the
trading interest expires and, if the time in force is less than one
day, the time when the trading interest expires); (c)(10) (the time
limit during which the trading interest is in force); (c)(11) (any
instructions to modify or cancel the trading interest); (c)(12) (the
type of account for which the trading interest is submitted);
(c)(13) (date and time that the trading interest was executed);
(c)(14) (price at which the trading interest is executed); and
(c)(15) (size of the trading interest executed).
\167\ See Regulation ATS Adopting Release, supra note 31, at
70878.
---------------------------------------------------------------------------
In addition, ATSs are required to establish adequate written
safeguards and written procedures \168\ to protect confidential trading
information and to separate ATS functions from other broker-dealer
functions, including principal and customer trading pursuant to Rule
301(b)(10).\169\ Furthermore, all ATSs must adopt and implement
adequate written oversight procedures to ensure that the above written
safeguards and procedures are followed.\170\ These requirements are
designed to help prevent the potential for abuse of subscriber
confidential trading information.\171\
---------------------------------------------------------------------------
\168\ These written safeguards and written procedures must
include: Limiting access to the confidential trading information of
subscribers to those employees of the ATS who are operating the
system or responsible for its compliance with these or any other
applicable rules; and implementing standards controlling employees
of the ATS trading for their own accounts.
\169\ See 17 CFR 242.301(b)(10); NMS Stock ATS Adopting Release,
supra note 2, Section VI.
\170\ See 17 CFR 242.301(b)(10)(ii).
\171\ See NMS Stock ATS Adopting Release, supra note 2, at
38864.
---------------------------------------------------------------------------
In addition, an ATS must not use in its name the word ``exchange,''
or any derivation of the word ``exchange'' pursuant to Rule
301(b)(11).\172\ The Commission believes that the use of the word
``exchange'' by an ATS would be deceptive and could lead investors to
believe incorrectly that such ATS is registered as a national
securities exchange.\173\
---------------------------------------------------------------------------
\172\ See 17 CFR 242.301(b)(11); Regulation ATS Adopting
Release, supra note 31, Section II.C.
\173\ See Securities Exchange Act Release No. 39884 (April 17,
1998), 63 FR 23504, 23523 (April 29, 1998) (``Regulation ATS
Proposing Release'').
---------------------------------------------------------------------------
The Commission is proposing amendments to facilitate an orderly
transition for Communication Protocol Systems to comply with the
applicable conditions of the Regulation ATS exemption.\174\ The
Commission understands that some Communication Protocol Systems are not
currently registered as broker-dealers.\175\ To become a registered
broker-dealer, these Communication Protocol Systems would be required
to file Form BD with the Commission and complete FINRA's processes for
new members.\176\ The Commission is proposing to allow Communication
Protocol Systems that are not registered as broker-dealers at the time
the proposed rule would be effective, if adopted, to provisionally
operate pursuant to the Rule 3a1-1(a)(2) exemption while their broker-
dealer registration is pending until the earlier of (1) the date the
ATS registers as a broker-dealer under Section 15 of the Exchange Act
or Section 15C(a)(1)(A) of the Exchange Act and becomes a member of a
national securities association or (2) the date 210 calendar days after
the effective date of any final rule.\177\ The 210 calendar day period
is designed to provide time for a Communication Protocol System to
submit its broker-dealer registration application, or continuing
membership application, as applicable, and for FINRA to conduct its
review of new member application and continuing member application. The
proposed transition period is designed to provide a Communication
Protocol System that is not a registered broker-dealer adequate time to
comply with the necessary broker-dealer registration requirements under
Regulation ATS without disrupting its market or its participants.
---------------------------------------------------------------------------
\174\ For purposes of the rule text, the Commission is proposing
to apply the transitional rules to ``Newly Designated ATSs.''
\175\ A registered broker-dealer that operates a Communication
Protocol System and is currently a FINRA member may, under FINRA
rules, be required to file a Continuing Membership Application with
FINRA noticing material changes to business operations in connection
with its operation of an ATS.
\176\ After receiving a substantially complete application
package, FINRA must review and process it within 180 calendar days.
See ``How to Become a Member--Member Application Time Frames''
available at <a href="https://www.finra.org/registration-exams-ce/broker-dealers/how-become-member-membership-application-time-frames">https://www.finra.org/registration-exams-ce/broker-dealers/how-become-member-membership-application-time-frames</a>. See
also FINRA Rule 1014.
\177\ See proposed revisions to Rule 301(b)(1). This transition
period for the proposed rule, if adopted, would also apply to
Currently Exempted Government Securities ATSs (i.e., Legacy
Government Securities ATSs formerly not required to comply with
Regulation ATS pursuant to the exemption under Sec. 240.3a1-1(a)(3)
prior to effective date of any final rule) not registered as a
broker-dealer. See infra note 283.
---------------------------------------------------------------------------
Proposed Rule 301(b)(2)(i) requires ATSs (other than Covered ATSs)
\178\ to file an initial operation report on Form ATS at least 20 days
before commencing operations; however, Communication Protocol Systems
that seek to operate as ATSs already will be operating when the
proposed rule, if adopted, becomes effective. To avoid disruption of
the services of the ATS, the Commission is proposing to amend Rule
301(b)(2)(i) to require Communication Protocol Systems (other than
those that are Covered ATSs) \179\ to file an initial operation report
on Form ATS no later than 30 calendar days after the effective date of
any final rule.\180\ The Commission is also proposing changes, as
discussed below, to Rule 301(b)(2)(viii) and Rule 304 to facilitate the
transition for Communication Protocol Systems that are Covered ATSs to
file Form ATS-N.\181\ Requiring Communication Protocol Systems to file
a Form ATS with the Commission at the proposed time would provide the
Commission with information about its
[[Page 15512]]
operations and facilitate oversight of the systems.
---------------------------------------------------------------------------
\178\ ``Covered ATS'' is defined infra note 257. The Commission
is proposing changes to Rule 301(b)(2)(i) to clarify that the
requirement to file Form ATS does not apply to ATSs other than
Covered ATSs. See proposed Rule 301(b)(2)(i).
\179\ The rule text uses the term ``Covered Newly Designated
ATS.''
\180\ See proposed changes to Rule 301(b)(2)(i).
\181\ See infra note 300 and Section IV.A.
---------------------------------------------------------------------------
Request for Comment
1. Should the Commission amend Exchange Act Rule 3b-16 as proposed?
Should the Commission adopt a more expansive or limited interpretation
of the definition of ``exchange''? Do commenters agree that, in the
current market, Communication Protocol Systems function as market
places that conduct similar activities as exchanges do? Would any
systems that conduct similar activities as exchanges that should be
included in proposed Rule 3b-16 be excluded? Are there any asset
classes or types of securities that should be excluded from the
definition of exchange? If so, why?
2. What are commenters' views on the potential consequences of
expanding or limiting the definition of ``exchange'' under Exchange Act
Rule 3b-16? What are commenters' views on how changing Rule 3b-16 could
benefit or harm investors and market participants? Are new systems that
meet the definition of exchange likely to choose to operate as ATSs
instead of national securities exchanges?
3. Should the Commission adopt the proposed definition of ``trading
interest'' under Exchange Act Rule 3b-16? Should the definition of
``trading interest'' require attributes to be identified in addition to
at least the security and either quantity, direction (buy or sell), or
price? Alternatively, would only one of the security, quantity,
direction (buy or sell), or price be adequate to indicate trading
interest? Should the definition of ``exchange'' continue to be limited
to systems that use orders? If so, why?
4. Should the Commission revise Exchange Act Rule 3b-16 to focus on
bringing together buyers and sellers, rather than bringing together
orders (or trading interest)? Would the proposed revisions to the rule
appropriately describe systems that use non-firm trading interest to
allow participants to communicate their trading interest?
5. Should the Commission revise Exchange Act Rule 3b-16(a)(2) to
describe a system that ``makes available established, non-discretionary
methods'' under which buyers and sellers interact? Should the
Commission revise the language further to clarify that a system
provider that makes available a trading facility or communication
protocol by way of a third party or affiliate would fall within the
criteria of Rule 3b-16(a)(2)? Should there be any minimum or baseline
to the established methods a system must have to qualify as an
exchange? If so, what are they? Do commenters agree that making
available communication protocols, as discussed herein, is sufficient
to be an established, non-discretionary method under which buyers and
sellers can interact?
6. Should the Commission remove the reference to ``multiple'' in
Rule 3b-16(a)(1))? If so, why? If not, why not?
7. Should Communication Protocol Systems that choose to comply with
Regulation ATS be subject to all of the requirements of Regulation ATS?
Are there certain requirements of Regulation ATS that should or should
not be applicable to Communication Protocol Systems, or certain
Communication Protocol Systems? For example, are the current Regulation
ATS recordkeeping requirements appropriate for Communication Protocol
Systems? Should the Commission require a Communication Protocol System
that chooses to operate as an ATS to create and maintain records that
are not otherwise required by Rule 301(b)(8) of Regulation ATS? Is
there anything that is not currently among the conditions to the
Regulation ATS exemption that a Communication Protocol System and/or an
existing ATS should comply with as part of Regulation ATS? And if so,
why?
8. Should the Commission amend Regulation ATS, Form ATS, Form ATS-
R, or Form ATS-N in any way to be more tailored to Communication
Protocol Systems? If so, how?
9. Are the proposed transition periods for Communication Protocol
Systems appropriate? Should the Commission provide Communication
Protocol Systems more or less time to comply with any of the
requirements of Regulation ATS? Please explain.
10. Is the Commission's proposal that a Newly Designated ATS must
file an initial operation report on Form ATS no later than 30 calendar
days after the effective date of any final rule, if adopted,
appropriate? If not, should the Commission provide more time or less
time for a Newly Designated ATS to file an initial Form ATS?
11. Should the Commission allow a Newly Designated ATS that is not
registered as a broker-dealer to operate pursuant to the Rule 3a1-
1(a)(2) exemption on a provisional basis? Does the proposal to allow
such ATSs a maximum 210 calendar days to comply with the broker-dealer
registration requirement provide an appropriate amount of time to
register as a broker-dealer? If not, what, if any, transition period
would be appropriate and why?
III. Proposed Changes Applicable to Government Securities ATSs
A. ATS Markets for Government Securities
Government securities \182\ play a critical role in the U.S. and
global economies. Among other things, for example, Treasury rates are a
fundamental benchmark for pricing virtually all other financial
assets.\183\ Systems currently operating as ATSs, particularly those
that operate in the secondary interdealer markets for the most-recently
issued (``on-the-run'') U.S. Treasury Securities, have become a
significant location of trading interest for government
securities.\184\ Specifically, most interdealer trading takes place on
electronic platforms provided by interdealer brokers that operate limit
order books, with electronic interdealer trading being
[[Page 15513]]
concentrated in on-the-run Treasury securities.\185\ In July 2021,
average daily trading in government securities totaled $978 billion, or
roughly 95 percent of all fixed income trading volume in the U.S.\186\
---------------------------------------------------------------------------
\182\ Under the Exchange Act, government securities are defined
as, among other things, securities which are direct obligations of,
or obligations guaranteed as to principal or interest by, the United
States. See 15 U.S.C. 78c(42)(A). Government securities include U.S.
Treasury securities, debt securities issued or guaranteed by a U.S.
executive agency, as defined in 5 U.S.C. 105, or government-
sponsored enterprise, as defined in 2 U.S.C. 622(8), and Agency
Mortgage-Backed Securities (``MBSs''). Government securities also
include securities which are issued or guaranteed by the Tennessee
Valley Authority or by corporations in which the United States has a
direct or indirect interest and which are designated by the
Secretary of the Treasury for exemption as necessary or appropriate
in the public interest or for the protection of investors;
securities issued or guaranteed as to principal or interest by any
corporation the securities of which are designated, by statute
specifically naming such corporation, to constitute exempt
securities within the meaning of the laws administered by the
Commission; and any put, call, straddle, option, or privilege on one
of the aforementioned (subject to limited exceptions). 15 U.S.C.
78c(42)(B)-(C).
\183\ See Group of Thirty Working Group on Treasury Market
Liquidity, U.S. Treasury Markets: Steps Toward Increased Resilience.
Group of Thirty at 1 (2021) (``G30 Report''), available at <a href="https://group30.org/publications/detail/4950">https://group30.org/publications/detail/4950</a>.
\184\ See Recent Disruptions and Potential Reforms in the U.S.
Treasury Market: A Staff Progress Report, at 32, available at
<a href="https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf">https://home.treasury.gov/system/files/136/IAWG-Treasury-Report.pdf</a>
(``November 2021 IAWG Report''). The November 2021 IAWG Report is a
joint report issued by the Inter-Agency Working Group for Treasury
Market Surveillance (``IAWG''), which consists of staff from the
U.S. Department of the Treasury, the Board of Governors of the
Federal Reserve System, the Federal Reserve Bank of New York, the
Commission, and the Commodity Futures Trading Commission. Among
other things, the November 2021 IAWG report provides an overview of
the current structure of the Treasury market and a detailed analysis
of the recent disruptions to the Treasury market at the onset of the
COVID-19 pandemic in March 2020 as well as other recent disruptions
to the Treasury market. The report also sets forth what the IAWG
believes are the six guiding principles for the Treasury market and
provides an update about the work streams for specific policy
analysis being undertaken by the members of the IAWG.
\185\ See id. at 3.
\186\ See SIFMA Fixed Income Trading Volume, available at
<a href="https://www.sifma.org/resources/research/us-fixed-income-trading-volume/">https://www.sifma.org/resources/research/us-fixed-income-trading-volume/</a>. This includes U.S. Treasury Securities, Agency Mortgage-
Backed Securities, and Federal Agency Securities.
---------------------------------------------------------------------------
Legacy Government Securities ATSs now operate with complexity
similar to that of markets that trade NMS stocks in terms of use of
technology and speed of trading, the use of limit order books, order
types, algorithms, connectivity, data feeds, and the active
participation of principal trading firms (``PTFs'').\187\ For example,
based on the Commission's review of Form ATS filings by ATSs that trade
government securities and discussions with market participants, the
Commission believes that Legacy Government Securities ATSs often offer
subscribers a variety of order types to pursue both aggressive and
passive trading strategies and low latency, high-speed connectivity to
the ATS. These ATSs frequently use automated systems to match orders
anonymously on a price/time priority basis. Some Legacy Government
Securities ATSs also segment orders into categories by participants or
allow participants the ability to interact with specific counterparty
groups in the ATS and facilitate order interaction and execution.\188\
Likewise, Communication Protocol Systems are increasingly used as
electronic means to bring together buyers and sellers for government
securities and are particularly prevalent in the dealer-to-customer
market for U.S. Treasury and markets for off-the-run \189\ U.S.
Treasury Securities, Agency Securities,\190\ and repos.
---------------------------------------------------------------------------
\187\ See November 2021 IAWG Report, supra note 184, at 31. See
also NMS Stock ATS Adopting Release, supra note 2, at 38771 for a
discussion about the current operational complexities of NMS Stock
ATSs.
\188\ See also November 2021 IAWG Report, supra note 184, at 31;
Joint Staff Report: The U.S. Treasury Market on October 15, 2014, at
11, 35-36, available at <a href="https://www.sec.gov/files/treasury-market-volatility-10-14-2014-joint-report.pdf">https://www.sec.gov/files/treasury-market-volatility-10-14-2014-joint-report.pdf</a> (``October 15 Staff
Report''); Department of the Treasury Release No. 2015-0013 (January
22, 2016), Notice Seeking Public Comment on the Evolution of the
Treasury Market Structure, 81 FR 3928 (January 22, 2016) (``Treasury
Request for Information''). This evolution in the interdealer
secondary cash markets for U.S. Treasury Securities was also
highlighted in the October 15 Staff Report, the Treasury Request for
Information, and public comment received by the Commission. The
October 15 Staff Report is a joint report about the unusually high
level of volatility and rapid round-trip in prices that occurred in
the U.S. Treasuries market on October 15, 2014. Among other things,
the October 15 Staff Report provides an overview of the market
structure, liquidity, and applicable regulations of the U.S.
Treasury market, as well as the broad changes to the structure of
the U.S. Treasury market that have occurred over the past two
decades.
\189\ See infra note 193 for a description of ``off-the-run''
securities.
\190\ See James Collin Harkrader and Michael Puglia, Fixed
Income Market Structure: Treasuries vs. Agency MBS, Board of
Governors of the Federal Reserve System: FEDS NOTES (August 25,
2020), available at <a href="https://www.federalreserve.gov/econres/notes/feds-notes/fixed-income-market-structure-treasuries-vs-agency-mbs-20200825.htm">https://www.federalreserve.gov/econres/notes/feds-notes/fixed-income-market-structure-treasuries-vs-agency-mbs-20200825.htm</a> (``August 25th FEDS Notes'') (explaining the recent
evolution of the government securities market structure).
---------------------------------------------------------------------------
The most liquid and commonly traded government securities are U.S.
Treasury Securities, which are direct obligations of the U.S.
Government issued by the U.S. Department of the Treasury (``Treasury
Department''). The Treasury Department issues several different types
of securities, including Treasury bills, nominal coupons notes and
bonds, Floating Rate Notes, and Treasury Inflation Protected
Securities. Treasury nominal coupon notes and bonds, as well as
Treasury Inflation Protected Securities, may also be separated into
principal and interest payments and traded as STRIPS.\191\ For each
security type, the on-the-run securities are generally considered the
most liquid in the secondary market.\192\ Market participants commonly
refer to securities issued prior to ``on-the-run'' securities as ``off-
the-run'' securities.\193\ Market participants use U.S. Treasury
Securities as an investment instrument, hedging vehicle, and to source
orders and trading interest, among other things. U.S. banks commonly
own U.S. Treasury Securities due to their low risk and strong liquidity
characteristics. Additionally, U.S. Treasury Securities are often used
as collateral in lending arrangements or as margin on other financial
transactions.
---------------------------------------------------------------------------
\191\ STRIPS is the acronym for Separate Trading of Registered
Interest and Principal of Securities. STRIPS let investors hold and
trade the individual interest and principal components of eligible
Treasury notes and bonds as separate securities. STRIPS are Treasury
securities that don't make periodic interest payments. Market
participants create STRIPS by separating the interest and principal
parts of a Treasury note or bond. STRIPS can only be bought and sold
through a financial institution, broker, or dealer and held in the
commercial book-entry system. See TreasuryDirect, STRIPS, available
at <a href="https://www.treasurydirect.gov/instit/marketables/strips/strips.htm">https://www.treasurydirect.gov/instit/marketables/strips/strips.htm</a>.
\192\ On-the-run U.S. Treasury Securities are the most recently
issued nominal coupon securities. Nominal coupon securities pay a
fixed semi-annual coupon and are currently issued at original
maturities of 2, 3, 5, 7, 10, 20, and 30 years. These standard
maturities are commonly referred to as ``benchmark'' securities
because the yields for these securities are used as references to
price a number of private market transactions.
\193\ Off-the-run or ``seasoned'' U.S. Treasury Securities are
the issues that preceded the current on-the-run securities. The U.S.
Treasury Securities market also comprises futures and options on
U.S. Treasury Securities, and securities financing transactions in
which U.S. Treasury Securities are used as collateral. See Treasury
Request for Information, supra note 188, at 3928. For the purpose of
this proposal, the Commission focuses on the secondary cash market.
---------------------------------------------------------------------------
For U.S. Treasury Securities, the secondary market is bifurcated
between the dealer-to-customer market, in which dealers trade with
their customers (e.g., investment companies, pension funds, insurance
companies, corporations, or retail), and the interdealer market, in
which dealers and specialty firms trade with one another.\194\
Customers, also referred to as ``end users,'' have not traditionally
traded directly with other end users.\195\ Rather, end users primarily
trade with dealers, and dealers use the interdealer market as a source
of liquidity to help facilitate their trading with clients in the
dealer-to-customer market. Trading in the U.S. Treasury Securities
dealer-to-customer market is generally--and has historically been--
conducted bilaterally using voice, and more recently, electronically
through the use of Communication Protocol Systems, most commonly using
an RFQ protocol. Broker-dealers also internalize a portion of their
customer flow, although the extent to which broker-dealers internalize
is unclear.\196\
---------------------------------------------------------------------------
\194\ See id.
\195\ See id.
\196\ See id. For the purposes of this proposal, internalization
refers to a broker filling a customer order either from the firm's
own inventory or by matching the order with other customer order
flow, instead of sending the order to an interdealer market for
execution. See id. at 3928 n.5.
---------------------------------------------------------------------------
In the interdealer market, the majority of trading in on-the-run
U.S. Treasury Securities currently occurs on ATSs using limit order
books supported by advanced electronic trading technology.\197\
Furthermore, interdealer trading for on-the-run U.S. Treasury
Securities is generally concentrated within a very small number of
ATSs, especially when compared to the market for NMS stocks, which is
dispersed among many trading venues.\198\ While
[[Page 15514]]
trading in the most liquid NMS stocks occur on a variety of trading
venues (e.g., exchanges, ATSs, single-dealer broker platforms), the
majority of overall trading in the interdealer secondary market for on-
the-run U.S. Treasury Securities occurs on ATSs.\199\ For example,
during the first nine months of 2021, one ATS accounted for $14.9
trillion in total dollar volume in all government securities, the
majority of which were on-the-run U.S. Treasury Securities.\200\ For
off-the-run U.S. Treasury Securities,\201\ the majority of interdealer
trading occurs via transactions through traditional voice-assisted
interdealer broker platforms and Communication Protocol Systems that
offer various trading protocols to bring together buyers and
sellers,\202\ though some interdealer trading of off-the-run U.S.
Treasury Securities does occur on ATSs.\203\
---------------------------------------------------------------------------
\197\ See October 15 Staff Report, supra note 188, at 11, 35-36.
See also Bloomberg Letter at 5, stating that liquid on-the-run
government securities are mostly traded on limit order books.
\198\ The growth of electronic trading has contributed to a
marked shift in the composition of the interdealer cash market for
U.S. Treasury Securities over time. Traditionally, interdealer
brokers only allowed primary dealers to access their trading venues.
After 1992, however, interdealer brokers expanded access to all
entities that were netting members of the Government Securities
Clearing Corporation (which is now the Fixed Income Clearing
Corporation's Government Securities Division). Thereafter, other
entities gained access to these trading venues through their prime
brokers, who themselves had access, and in recent years the trading
venues granted direct access to an even wider range of participants,
including non-dealers, which account for more than half of the
trading activity in the futures and electronically brokered
interdealer cash markets. See October 15 Staff Report, supra note
188, at 36. See also Treasury Request for Information, supra note
188, at 3928.
\199\ See infra Table VIII.2 and accompanying text.
\200\ For an additional discussion of trading volume in the U.S.
bond market as a whole and U.S. Treasury Securities, see infra
Section VIII.B.2.
\201\ Also, as noted in the October 15 Staff Report issued by
the Treasury Department, Board of Governors of the Federal Reserve
System, Federal Reserve Bank of New York, the Commission, and U.S.
Commodity Futures Trading Commission, trading in off-the-run U.S.
Treasury Securities has always been less active than trading in on-
the-run U.S. Treasury Securities, and price discovery in the cash
markets primarily occurs in on-the-run securities. See October 15
Staff Report, supra note 188 at n.7.
\202\ See November 2021 IAWG Report, supra note 184, at 3. See
also Bloomberg Letter at 5, stating that less liquid off-the-run
government securities are mostly traded using methods other than
limit order books.
\203\ While trading in on-the-run securities likely accounts for
more than half of total daily trading volumes, off-the-run U.S.
Treasury Securities make up over 95 percent of the outstanding
marketable U.S. Treasury Securities. See G30 Report, supra note 183,
at 1, n.2.
---------------------------------------------------------------------------
Another type of government securities is Agency Securities. Agency
Securities include securities issued by or guaranteed by U.S.
Government corporations or U.S. Government sponsored enterprises
(``GSEs'').\204\ Agency Securities, which may not be backed by the full
faith and credit of the U.S. Government, are generally considered to be
very liquid and offer state and local tax advantages to the holder.
Market participants can use ATSs to buy and sell Agency Securities,
although, based on the Commission's review of Form ATS-R filings,
transaction volume of Agency Securities is not as large as that of U.S.
Treasury Securities on ATSs.\205\ Investors, banks, and other market
participants often acquire Agency Securities in the secondary market to
support various investing strategies, such as hedging against other
more risky investments in a given portfolio. Agency Securities also
trade on Communication Protocol Systems where buyers and sellers can
use RFQ protocols, for example, to engage in price discovery, find a
counterparty, and negotiate and execute a transaction.
---------------------------------------------------------------------------
\204\ See U.S. Department of the Treasury Resource Center,
``Fixed Income: Agency Securities,'' available at <a href="https://www.treasury.gov/resource-center/faqs/Markets/Pages/fixedfederal.aspx">https://www.treasury.gov/resource-center/faqs/Markets/Pages/fixedfederal.aspx</a>. For example, the Government National Mortgage
Association (``Ginnie Mae'') is a U.S. Government corporation that
issues mortgage-backed securities guaranteed by the full faith and
credit of the U.S. Government. The assets collateralized into the
securities issued by Ginnie Mae are federally insured and guaranteed
mortgage loans. Agency Securities issued by GSEs include those
issued by the Federal Home Loan Banks (``FHLBs''), the Federal
National Mortgage Association (``Fannie Mae''), the Federal Home
Loan Mortgage Corporation (``Freddie Mac''), and the Student Loan
Marketing Association (``Sallie Mae''). Agency Securities issued by
GSEs are not normally backed by the full faith and credit of the
U.S. Government and therefore, may present some default and credit
risk.
\205\ Additionally, repos on government securities are also
traded on some ATSs.
---------------------------------------------------------------------------
Repos provide short-term financing (often overnight) to help fund
the borrower's (usually a broker-dealer) trading or lending activities.
However, the collateral is sold to the lender, and the repo obligates
the borrower to repurchase the collateral. U.S. Treasury Securities are
frequently used as the underlying collateral of a repo. Several ATSs
have provided notice on their Form ATS disclosures that they facilitate
the trading of repos. Much like the markets for U.S. Treasury
Securities and Agency Securities, repo trading has historically been
conducted bi-laterally by voice; however, over the past decade,
electronic trading of repos on Communication Protocol Systems has
increased significantly. Electronic trading of repos is primarily
conducted via RFQ protocols, and many systems for trading in repos now
offer electronic trading options.
With regard to the interdealer secondary markets for on-the-run
U.S. Treasury Securities, the continued growth of electronic trading
has contributed to an increased presence of PTFs in the market
place.\206\ Currently, PTFs account for the majority of trading and
provide top-of-the-book liquidity for on-the-run U.S. Treasury
Securities on electronic interdealer trading venues.\207\ From January
1, 2021 to June 30, 2021, PTFs traded on 13 Government Securities ATSs
accounting for approximately 48.6 percent of total on-the-run
Government Securities ATS trading volume.\208\ PTFs usually have direct
access to electronic interdealer trading venues for U.S. Treasury
Securities, and as is the case with the equity markets, PTFs trading on
the electronic interdealer trading venues for on-the-run U.S. Treasury
Securities often employ automated algorithmic trading strategies that
rely on speed and allow the PTFs to cancel or modify quotes in response
to perceived market events.\209\ Furthermore, most PTFs trading U.S.
Treasury Securities on these trading venues for on-the-run U.S.
Treasury Securities also restrict their activities to principal trading
and do not hold positions long term, while dealers use the interdealer
market as a source of orders and trading interest to help facilitate
their trading with clients in the dealer-to-customer market.\210\ As
explained in the October 15 Staff Report, the increase in trading by
PTFs in the interdealer market may affect the amount of liquidity
available to end users in the dealer-to-customer market.\211\
---------------------------------------------------------------------------
\206\ PTFs are not, however, very active in the electronic
markets for Agency Securities. See August 25th FEDS Notes, supra
note 190 (``Though parts of the agency MBS market have moved from
voice-based to screen-based trading since the early 2000s,
algorithmic high-frequency electronic trading still does not
comprise a meaningful share of average daily volume and the market
remains devoid of PTF participation.'').
\207\ See November 2021 IAWG Report, supra note 184, at 5. See
also October 15 Staff Report, supra note 188, at 36; Remarks of
Deputy Secretary Justin Muzinich at the 2019 U.S. Treasury Market
Structure Conference (September 23, 2019), available at <a href="https://home.treasury.gov/news/press-releases/sm782">https://home.treasury.gov/news/press-releases/sm782</a>.
\208\ See infra Table VIII.2. (ATS PTF volume/ATS volume) x 100
= PTF share of ATS volume (%).
\209\ See October 15 Staff Report, supra note 188, at 32, 35-36,
39.
\210\ See November 2021 IAWG Report, supra note 184, at 5;
October 15 Staff Report, supra note 188, at 38.
\211\ See October 15 Staff Report, supra note 188, at 37.
---------------------------------------------------------------------------
In response to the 2020 Proposal, the Commission received several
comments that broadly supported expanding the regulatory framework
under Regulation ATS with respect to Government Securities ATSs.\212\
Commenters stated that ATSs have become increasingly important in the
government securities market.\213\ One commenter stated that, given
that Government Securities ATSs closely resemble NMS Stock ATSs, it
would be appropriate to impose similar regulatory oversight, including
regulatory oversight by the Commission
[[Page 15515]]
and FINRA.\214\ Likewise, another commenter stated that many of the
concerns surrounding potential conflicts of interest that arise between
an ATS and the activities of its bank/broker-dealer operator and
affiliates--and the transparency of an ATS's operations--are equally
relevant with respect to ATSs that transact in government securities as
to NMS Stock ATSs.\215\ In addition, one commenter stated that critical
intermediaries in the U.S. Treasury market are ``effectively
unregulated'' as trading venues or dealers, and this hampers
availability of information concerning trading in these critical
markets, and that oversight of the core ``plumbing'' of these critical
markets, which determines their resiliency, is lacking.\216\ This
commenter stated that several ATSs now dominate the trading of U.S.
Treasury Securities and agency mortgage backed securities, and that
ensuring that Regulation ATS and Regulation SCI apply to these entities
will provide for additional data and create more transparency into the
trading around those critical markets.\217\ This commenter also stated
that expanding Regulation ATS with respect to ATSs that trade U.S.
Treasuries has also become important as the role of PTFs has become
more significant in the U.S. Treasury markets and related repo
markets.\218\
---------------------------------------------------------------------------
\212\ See, e.g., BrokerTec Letter, SIFMA Letter, AFREF Letter.
\213\ See FINRA Letter.
\214\ See SIFMA Letter at 2.
\215\ See also MFA Letter at 4.
\216\ See AFREF Letter at 1.
\217\ See id.
\218\ See id. at 2 (stating that the growing role of PTFs means
that much trading activity is not coming from long-term investors
but rather proprietary trading firms who may trade in-and-out of
their positions several times in a day and are likely to react
sharply to market volatility).
---------------------------------------------------------------------------
B. Heightened Regulatory Requirements Under Regulation ATS for
Government Securities ATSs
The vast majority of ATSs that operate today do so pursuant to the
exemption provided by Exchange Act Rule 3a1-1(a)(2), which requires the
ATSs to be in compliance with Regulation ATS, which includes, among
other things, registering as broker-dealers. Currently Exempted
Government Securities ATSs, however, operate pursuant to Exchange Act
Rule 3a1-1(a)(3) \219\ and Rule 301(a)(4)(ii)(A).\220\ These provisions
currently exempt an ATS from compliance with the requirements in Rule
301(b) of Regulation ATS \221\ if, in relevant part, the ATS (1) is
registered as a broker-dealer under Sections 15(b) \222\ or 15C \223\
of the Exchange Act, or is a bank, and (2) limits its securities
activities to government securities (as defined in Section 3(a)(42) of
the Exchange Act), repos, any puts, calls, straddles, options, or
privileges on government securities, other than puts, calls, straddles,
options, or privileges that: (i) Are traded on one or more national
securities exchanges; or (ii) for which quotations are disseminated
through an automated quotation system operated by a registered
securities association, and commercial paper.\224\ Accordingly, such
Currently Exempted Government Securities ATSs are not required to
register as a national securities exchange or comply with Regulation
ATS.\225\ To the Commission's knowledge, most Currently Exempted
Government Securities ATSs operating pursuant to this exemption
register as broker-dealers with the Commission.\226\
---------------------------------------------------------------------------
\219\ 17 CFR 240.3a1-1(a)(3).
\220\ 17 CFR 242.301(a)(4)(ii)(A).
\221\ 17 CFR 242.301(b).
\222\ See 15 U.S.C. 78o(b) (pertaining to the registration and
regulation of brokers and dealers).
\223\ See 15 U.S.C. 78o-5 (pertaining to the registration and
regulation of government securities brokers and dealers).
\224\ See 15 U.S.C. 78c(a)(42). The definition of ``government
securities'' in Section 3(a)(42) of the Exchange Act (and,
therefore, references to ``government securities'' throughout this
proposal) includes certain puts, calls, straddles, options, or
privileges on government securities, other than puts, straddles,
options, or privileges that: Are traded on one or more national
securities exchanges; or for which quotations are disseminated
through an automated quotation system operated by a registered
securities association. See supra note 182.
\225\ See 17 CFR 242.301(a)(4)(i) and (a)(4)(ii)(A). Although
not required to register as a national securities exchange or comply
with Regulation ATS, a Currently Exempted Government Securities ATS
may need to register as a broker-dealer under Section 15(b) or as a
government securities broker or government securities dealer
pursuant to Exchange Act Section 15C, and comply with the associated
regulatory requirements. See, e.g., 17 CFR chapter IV, subchapter
A--Regulations under Section 15C of the Securities Exchange Act of
1934.
\226\ Some ATSs that are eligible for the exemption voluntarily
comply with Regulation ATS, even though ATSs that trade only
government securities are not required to comply with Regulation ATS
at all.
---------------------------------------------------------------------------
ATSs that do not limit their securities activities solely to
government securities or repos, trading for example corporate bonds or
municipal securities, cannot use this exemption. Such ATSs must either
register as an exchange or comply with Regulation ATS pursuant to
Exchange Act Rule 3a1-1(a)(2), which includes, among other things,
registering as a broker-dealer under Section 15 of the Exchange
Act.\227\ Government Securities ATSs that are currently subject to
Regulation ATS must report transactions in U.S. Treasury Securities and
Agency Securities to the Trade Reporting and Compliance Engine
(``TRACE''),\228\ and FINRA publicly disseminates data about these
transactions. Currently, FINRA publishes weekly aggregated transaction
information on U.S. Treasury Securities and disseminates certain
transaction information on Agency Securities immediately upon receipt
of a transaction report.\229\ Today, Legacy Government Securities ATSs
are subject only to certain provisions of Regulation ATS because not
all the provisions are applicable to trading in government
securities.\230\ In particular, government securities are not included
in any category of securities under the Fair Access Rule.\231\ Today,
the categories of securities under the Fair Access Rule only include
NMS stocks, equity securities that are not NMS stocks and for which
transactions are reported to an SRO, municipal securities, and
corporate debt securities.\232\ In addition, Regulation SCI does not
apply to ATSs with respect to their trading in
[[Page 15516]]
government securities.\233\ The Capacity, Integrity, and Security Rule
under Rule 301(b)(6) \234\ also does not apply to the government
securities activities of an ATS.\235\
---------------------------------------------------------------------------
\227\ See supra notes 130-131 and accompanying text.
\228\ See FINRA Rule 6730(a)(1) requires FINRA members to report
transactions in TRACE-Eligible Securities, which FINRA Rule 6710
defines to include U.S. Treasury Securities and Agency Securities.
For each transaction in U.S. Treasury Securities and Agency
Securities, a FINRA member would be required to report the CUSIP
number or similar numeric identifier or FINRA symbol; size (volume)
of the transaction; price of the transaction (or elements necessary
to calculate price); symbol indicating whether transaction is a buy
or sell; date of trade execution (``as/of'' trades only); contra-
party's identifier; capacity (principal or agent); time of
execution; reporting side executing broker as ``give-up'' (if any);
contra side introducing broker (in case of ``give-up'' trade); the
commission (total dollar amount), if applicable; date of settlement;
if the member is reporting a transaction that occurred on an ATS
pursuant to FINRA Rule 6732, the ATS's separate Market Participant
Identifier (``MPID''); and trade modifiers as required. For when-
issued transactions in U.S. Treasury Securities, a FINRA member
would be required to report the yield in lieu of price. See FINRA
Rule 6730(c).
\229\ FINRA Rule 6750(a) requires FINRA to disseminate
information on all transactions on certain securities, including
Agency Securities (but excluding U.S. Treasury Securities),
immediately upon receipt of the transaction report. FINRA is
permitted to publish or distribute weekly aggregated transaction
information and statistics on U.S. Treasury Securities, and has
stated that it intends to publish weekly volume information
aggregated by U.S. Treasury subtype (e.g., Bills, Floating Rate
Notes, Treasury Inflation-Protected Securities, and Nominal
Coupons). See Securities Exchange Release No. 87837 (December 20,
2019), 84 FR 71986 (December 30, 2019) (approving a proposed rule
change to allow FINRA to publish or distribute aggregated
transaction information and statistics on U.S. Treasury Securities).
\230\ See 17 CFR 242.301(b)(1), (2), and (7) through (11). The
order display and execution access provisions under Rule 301(b)(3)
and the related fee restrictions of Rule 301(b)(4) of Regulation ATS
only apply to an ATS's NMS stock activities. See 17 CFR
242.301(b)(3) and (4). See also supra Section II.D.2 (discussing the
requirements for compliance with the Regulation ATS exemption).
\231\ 17 CFR 242.301(b)(5). See also supra notes 153-157 and
accompanying text.
\232\ See 17 CFR 242.301(b)(5).
\233\ See infra Section III.C (describing the types of entities
that are currently subject to the requirements of Regulation SCI).
\234\ 17 CFR 242.301(b)(6).
\235\ See supra notes 157-158 and accompanying text.
---------------------------------------------------------------------------
Finally, Government Securities ATSs are not required to comply with
rules applicable to ATSs that trade NMS stocks, including the
obligation to file a public Form ATS-N pursuant to Rule 304 of
Regulation ATS.\236\ ATSs that transact in government securities or
repos are also not required to comply with the order display and
execution access provisions under Rule 301(b)(3) \237\ and the related
fee restrictions of Rule 301(b)(4),\238\ both of which only apply to an
ATS's NMS stock activities.
---------------------------------------------------------------------------
\236\ 17 CFR 242.304. See also supra notes 139-143 and
accompanying text.
\237\ See supra notes 149-151 and accompanying text.
\238\ See supra note 152 and accompanying text.
---------------------------------------------------------------------------
Despite the critical role of government securities in the U.S. and
global economy, the significant volume in government securities
transacted on ATSs, and these ATSs' growing importance to investors and
overall securities market structure, Currently Exempted Government
Securities ATSs are exempt from exchange registration and are not
required to comply with Regulation ATS. In addition, Communication
Protocol Systems that transact in government securities and/or repos,
but do not currently meet the definition of ``exchange,'' are not
subject to exchange registration requirements and are likewise not
required to comply with Regulation ATS.\239\ Furthermore, ATSs that
trade both government securities and non-government debt securities
(e.g., corporate bonds) are not subject to all the provisions of
Regulation ATS. Market participants today have limited access to
information that permits them to adequately compare and contrast how
they can use a Government Securities ATS or how their trading interest
would be handled by Government Securities ATSs.\240\ In addition,
Government Securities ATSs are not currently subject to the Fair Access
Rule and Regulation SCI, which would help ensure the fair treatment of
subscribers and address technological vulnerabilities, and improve the
Commission's oversight, of the core technology of key entities in the
markets for government securities.\241\ Given these concerns, and
comments received on the 2020 Proposal, the Commission is re-proposing
and revising the amendments described below.
---------------------------------------------------------------------------
\239\ See supra Section II.A.
\240\ See, e.g., 2020 Proposal, supra note 4, at 87125.
\241\ See id. at Section III.B.4 (discussing the Fair Access
Rule) and III.C (discussing Regulation SCI).
---------------------------------------------------------------------------
1. Proposed Definition of Government Securities ATS
The Commission is re-proposing to amend Rule 300 of Regulation ATS
to define ``Government Securities ATS'' to mean an alternative trading
system, as defined in Rule 300(a), that trades government securities,
as defined in section 3(a)(42) of the Exchange Act (15 U.S.C.
78c(a)(42)), or repurchase and reverse repurchase agreements on
government securities.\242\ To meet the definition of a Government
Securities ATS, the organization, association, person, group of
persons, or system must meet the definition of an alternative trading
system under Rule 300(a) of Regulation ATS.\243\ The Commission is also
re-proposing that a Government Securities ATS shall not trade
securities other than government securities or repos \244\ and that
trading of securities other than government securities or repos would
require the separate filing of a Form ATS or a Form ATS-N, depending on
the types of securities traded.\245\ Other than complying with Rule 304
and filing Form ATS-N, this amendment would not, however, impose new
compliance requirements on ATSs that currently trade government
securities in addition to non-government securities.\246\ Under the
proposal, if a broker-dealer operator currently operates an ATS for
government securities and non-government securities (for example,
corporate bonds), the broker-dealer operator would separately be
required to comply with Regulation ATS for: (1) A Government Securities
ATS that would trade government securities, which would be subject to
Rule 304, and file disclosures on Form ATS-N, as proposed to be revised
and (2) a non-Government Securities ATS (that, for example, would trade
corporate bonds), which would not be subject to Rule 304, and file
disclosures on its existing Form ATS, as amended to remove references
to government securities.
---------------------------------------------------------------------------
\242\ See proposed Rule 300(l).
\243\ 17 CFR 242.300(a). See Regulation ATS Adopting Release,
supra note 31, at 70851-52.
\244\ See proposed Rule 300(l).
\245\ An ATS that does not trade NMS stocks or government
securities, as proposed, must file Form ATS. If the broker-dealer
operates an ATS that trades NMS stocks and an ATS that trades
government securities, it would be required to file a separate Form
ATS-N for each of the NMS Stock ATS and Government Securities ATS.
\246\ Broker-dealers that operate Government Securities ATSs
that are currently subject to Regulation ATS already must have
established written safeguards and written procedures to protect
subscribers' confidential trading information, pursuant to Rule
301(b)(10), and already must make and keep records pursuant to Rule
301(b)(8) that are tailored to the types of securities the ATS
trades and the subscribers that trade those securities on the ATS.
The Commission believes the proposal is broadly consistent with the
manner in which broker-dealers that operate NMS Stock ATSs and non-
NMS Stock ATSs currently comply with Regulation ATS. For further
discussion, see infra Section III.B.3.
---------------------------------------------------------------------------
In response to the 2020 Proposal, the Commission received one
comment letter opposing the proposed definition of Government
Securities ATS.\247\ This commenter stated that separating trading
activity in government securities and repos from non-NMS stock trading
activity could impose administrative and operational burdens on both
Government Securities ATSs and subscribers.\248\ The commenter stated
that the Commission did not explain why requiring a Government
Securities ATS to separate its operations from other non-NMS Stock ATS
trading activity would improve Commission oversight or other regulatory
goals.\249\
---------------------------------------------------------------------------
\247\ See ICE Bonds Letter I at 5.
\248\ See id. The commenter stated that the initial set-up of a
new Government Securities ATS would require, among other things, the
development of a matching engine, separate connectivity for
subscribers, new clearing connectivity, additional personnel to
support trading operations of the Government Securities ATS, and
regulatory controls (e.g., Rule 15c3-5). The commenter further
stated that these requirements would ultimately lead to fewer venues
for subscribers to trade and hedge and concentrate trading among a
few large Government Securities ATSs, as smaller Legacy Government
Securities ATSs may determine that this separation requirement is
cost prohibitive. In addition, the commenter stated that if a
subscriber has to execute a corporate bond on one ATS and sell the
treasury on a different ATS, there is an administrative and
operational burden placed on the subscriber, as well as additional
economic and market risk to the subscriber as the price on the other
venue may move by the time the hedge trade is initiated.
\249\ See id.
---------------------------------------------------------------------------
The proposed definition of Government Securities ATS, however,
would not require operational separation by a Government Securities
ATS, and the operational costs that the commenter described would
therefore not apply.\250\ The proposed definition would not, for
example, require the Government Securities ATS to develop a new
matching engine nor require changes with regard to how subscribers
enter trading interest into the ATS. Other than requiring the
Government Securities ATS to separately comply with the requirements of
Regulation ATS (and, as applicable, Regulation SCI), the proposed
definition does not create new compliance requirements on
[[Page 15517]]
Government Securities ATSs.\251\ Under the proposed rule, a broker-
dealer operator for an ATS that currently trades both government
securities and corporate debt securities, for example, would be
required to file a Form ATS-N for the trading of government securities
on a Government Securities ATS and a separate Form ATS for trading of
corporate debt securities on an ATS. In this example, the broker-dealer
operator for a Government Securities ATS and non-Government Securities
ATS may be required to disclose certain information on Form ATS-N about
the non-Government Securities ATS. For example, to the extent that any
persons support both the operation of the Government Securities ATS and
the ATS that trades corporate debt securities and have access to
subscriber confidential trading information for the Government
Securities ATS, the Government Securities ATS would need to disclose
that on Part II, Item 7 of Form ATS-N.\252\ In addition, the Government
Securities ATS would be required to provide under Part III, Item 11
information about interaction with non-government securities markets
(e.g., futures, currencies, swaps, corporate bonds).\253\
---------------------------------------------------------------------------
\250\ See id.
\251\ See supra note 246.
\252\ See infra Section IV.D.4.f.
\253\ See infra Section IV.D.5.k.
---------------------------------------------------------------------------
Further, the Commission believes that by stating that a Government
Securities ATS trades only government securities, the definition of
Government Securities ATS clarifies which regulatory requirements are
applicable for trading activity in government securities and non-
government securities. For example, a Government Securities ATS would
file a Form ATS-N specifically disclosing information regarding its
trading in government securities, which would enable market
participants to understand the ATS's government securities operations
and readily compare the ATS against other Government Securities ATSs.
To provide that the same approach applies to broker-dealers that
operate NMS Stock ATSs and non-NMS Stock ATSs, and to clarify
requirements applicable to NMS Stock ATSs, the Commission is proposing
to amend the definition of ``NMS Stock ATS'' to state that an NMS Stock
ATS shall not trade securities other than NMS stocks.\254\ Today,
securities other than NMS stocks are not traded in any NMS Stock ATS
and the proposed amendment to the definition of NMS Stock ATS would
have no impact on any existing ATS nor on the requirements applicable
to existing NMS Stock ATSs. Broker-dealer operators of NMS Stock ATSs
are currently required to file a Form ATS-N for NMS Stock ATS
operations and a separate Form ATS for any non-NMS Stock ATS
operations.\255\ This would not change under this proposal. In
addition, to facilitate the orderly transition to the heightened
requirements for Government Securities ATSs that are currently
operating, the Commission is defining such ATSs as Legacy Government
Securities ATSs.\256\
---------------------------------------------------------------------------
\254\ See proposed Rule 300(k).
\255\ See current Rule 301(b)(2)(viii).
\256\ See proposed Rule 300(n). See also supra note 5. See infra
notes 433-439 and accompanying text for a description of the filing
and effectiveness rules applicable to Legacy Government Securities
ATSs.
---------------------------------------------------------------------------
To help specify which ATSs are subject to Rule 304 requirements,
the Commission is proposing to define ``Covered ATS'' as an NMS Stock
ATS or Government Securities ATS, as applicable.\257\ The Commission is
also proposing to define ``Covered Newly Designated ATS'' to mean a
Newly Designated ATS that is a Government Securities ATS or NMS Stock
ATS, which the Commission believes would facilitate the transition of
Communication Protocol Systems that are NMS Stock ATSs or Government
Securities ATSs to the regulatory requirements of Regulation ATS.\258\
---------------------------------------------------------------------------
\257\ See proposed Rule 300(m).
\258\ See proposed Rule 300(s).
---------------------------------------------------------------------------
The Commission is also proposing to add definitions of ``U.S.
Treasury Security'' and ``Agency Security'' for purposes of Regulation
ATS.\259\ ``U.S. Treasury Security'' would mean a security issued by
the U.S. Department of the Treasury. ``Agency Security'' would mean a
debt security issued or guaranteed by a U.S. executive agency, as
defined in 5 U.S.C. 105, or government-sponsored enterprise, as defined
in 2 U.S.C. 622(8). The proposed definitions are designed to provide
the scope of securities a Government Securities ATS must include when
calculating whether the fair access requirements set forth in Rule
301(b)(5) are applicable and to facilitate compliance with the Fair
Access Rule.\260\
---------------------------------------------------------------------------
\259\ See proposed Rule 300(o)-(p).
\260\ See infra Section III.B.4. The proposed definitions are
similar to those in FINRA's rules. See FINRA Rules 6710(l) and
6710(p).
---------------------------------------------------------------------------
Request for Comment
12. Should the Commission adopt a more limited or expansive
definition of Government Securities ATS than the definition that is
being proposed? Given that, unlike the 2020 Proposal, the definition of
Government Securities ATS would now include Communication Protocol
Systems that transact in government securities and/or repos, do
commenters believe that the definition of Government Securities ATS
should be limited or expanded?
13. Should the Commission cite to the section 3(a)(42) (15 U.S.C.
78c(a)(42)) definition of government securities for purposes of
defining Government Securities ATS? Should the securities encompassed
by the definition (e.g., certain options on government securities) be
considered ``government securities'' for purposes of this regulation?
14. Should the Commission modify the proposed definitions of U.S.
Treasury Securities and Agency Securities in any way? For example,
should the proposed definitions of U.S. Treasury Securities and Agency
Securities be based on definitions in any other existing rules?
15. The proposed amendments to the definitions of NMS Stock ATS and
Government Securities ATS are not designed to limit a broker-dealer
operator for an NMS Stock ATS or Government Securities ATS with respect
to other types of securities that the broker-dealer operator may make
available for trading in an ATS that is subject to Rule 301(b)(2) of
Regulation ATS or how the broker-dealer operator may structure the
operations of its ATS businesses. Would the proposed amendments to the
definitions of NMS Stock ATS and Government Securities ATS impose any
operational or other burdens on the broker
[…truncated; see source link]Indexed from Federal Register on March 18, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.