Notice2022-26533
Self-Regulatory Organizations; Investors Exchange LLC; Order Granting Approval of a Proposed Rule Change To Amend Rule 11.190(g) To Provide an Alternative Calculation for Non-Displayed Pegged Order Types for Determining Whether a Quote Instability Condition Exists
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Published
December 7, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 87 Issue 234 (Wednesday, December 7, 2022)</title>
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[Federal Register Volume 87, Number 234 (Wednesday, December 7, 2022)]
[Notices]
[Pages 75099-75102]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-26533]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-96416; File No. SR-IEX-2022-06]
Self-Regulatory Organizations; Investors Exchange LLC; Order
Granting Approval of a Proposed Rule Change To Amend Rule 11.190(g) To
Provide an Alternative Calculation for Non-Displayed Pegged Order Types
for Determining Whether a Quote Instability Condition Exists
December 1, 2022.
I. Introduction
On September 27, 2022, the Investors Exchange LLC (``IEX'' or the
``Exchange'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to provide an alternative
calculation for non-displayed pegged order types to determine whether a
quote instability condition exists for purposes of determining when the
Exchange's proprietary Crumbling Quote Indicator (``CQI'') is to be
triggered. The proposed rule change was published for comment in the
Federal Register on October 17, 2022.\3\ The Commission received no
comments on the proposed rule change. This order approves the proposed
rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 96014 (October 11,
2022), 87 FR 62903 (``Notice'').
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II. Description of the Proposed Rule Change
Current CQI Operation
Pursuant to IEX Rule 11.190(g), the Exchange utilizes quoting
activity of eight away exchanges' Protected Quotations \4\ and a
mathematical
[[Page 75100]]
calculation to assess the probability of an imminent change to the
current Protected NBB \5\ to a lower price or imminent change to the
current Protected NBO \6\ to a higher price for a particular security.
When the quoting activity meets predetermined criteria, the System \7\
treats the quote as not stable (``quote instability'' or a ``crumbling
quote'') and the CQI is then ``on'' at that price level for two
milliseconds. During all other times, the quote is considered stable
and the CQI is ``off''. The System independently assesses the stability
of the Protected NBB and Protected NBO for each security. IEX
characterizes these order types and the CQI functionality as being
designed to ``counter the costs of `adverse selection' that
participants supplying liquidity incur when their orders are executed
at worse prices as a result of certain speed-based trading
strategies.'' \8\
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\4\ See IEX Rule 1.160(bb) (defining ``Protected Quotation'' as
an automated quotation that is calculated by IEX to be the best bid
or best offer of an exchange). Current IEX Rule 11.190(g) uses the
following eight exchanges' Protected Quotations: New York Stock
Exchange LLC, the Nasdaq Stock Market LLC, NYSE Arca, Inc., Nasdaq
BX, Inc., Cboe BYX Exchange, Inc., Cboe Bats BZX Exchange, Inc.,
Cboe EDGA Exchange, Inc., and Cboe EDGX Exchange, Inc.
(collectively, ``Signal Exchanges'').
\5\ See IEX Rule 1.160(cc).
\6\ See IEX Rule 1.160(cc).
\7\ See IEX Rule 1.160(nn).
\8\ Notice, supra note 3, at 62904.
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This proposal applies to the CQI formula that informs the exercise
of ``discretion'' by Discretionary Peg (``D-Peg'') \9\ orders, Primary
Peg (``P-Peg'') \10\ orders, and Corporate Discretionary Peg (``C-
Peg'') orders.\11\ Each of those resting peg order types, all of which
are non-displayed, passively rest at prices slightly less aggressive
than the near-side quote. When the quote is stable, those peg orders
exercise price discretion by ``jumping'' to a more aggressive price to
interact with an active incoming liquidity taking order when the quote
is stable. However, when the CQI comes on, those orders do not exercise
price discretion and instead continue to rest passively. Specifically,
D-Peg, P-Peg, and C-Peg orders rest at a pegged price that is the less
aggressive of one minimum price variant (``MPV'') \12\ less aggressive
than the primary quote (i.e., one MPV below (above) the NBB \13\ (NBO
\14\) for buy (sell) orders) or the order's limit price, if any.\15\ In
addition, when the CQI is on at the NBB (in the case of a buy order) or
NBO (in the case of a sell order), P-Peg orders are restricted by the
System from exercising price discretion to trade at the quote
instability determination price level (the ``CQI Price''), and D-Peg
and C-Peg orders are restricted by the System from exercising price
discretion to trade at the CQI Price or at more aggressive prices than
the CQI Price.
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\9\ See IEX Rule 11.190(b)(10).
\10\ See IEX Rule 11.190(b)(8).
\11\ See IEX Rule 11.190(b)(16). Note that C-Peg orders can only
be buy orders, so any discussion of D-Peg sell orders does not apply
to C-Peg orders. This proposal does not apply to Discretionary Limit
(``D-Limit'') orders, which can be displayed. See IEX Rule
11.190(b)(10).
\12\ See IEX Rule 11.210.
\13\ See IEX Rule 1.160(u).
\14\ See IEX Rule 1.160(u).
\15\ C-Peg orders are also constrained by the consolidated last
sale price of the security, and therefore cannot trade, book, or
exercise discretion at a price that is more aggressive than the
consolidated last sale price. See IEX Rule 11.190(b)(16).
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Proposed Alternative CQI Calculation
As proposed, Users \16\ of D-Peg, P-Peg and C-Peg orders will be
able to designate whether the order's price will be adjusted using the
existing quote instability calculation (hereinafter referred to as the
``Current CQI Calculation'') or the new proposed alternative quote
instability calculation (hereinafter referred to as the ``Alternative
CQI Calculation''). According to the Exchange, the Alternative CQI
Calculation is ``designed to incrementally increase the coverage of the
quote instability calculation in predicting whether a particular quote
is unstable by adjusting the logic underlying the quote instability
calculation and introducing enhanced functionality designed to increase
the number of crumbling quotes identified, while maintaining the quote
instability calculation's accuracy in predicting the direction and
timing of the next price change in the NBB or NBO, as applicable.''
\17\
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\16\ See IEX Rule 1.160(qq).
\17\ Notice, supra note 3, at 62904.
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The Alternative CQI Calculation applies four separate rule
categories of Protected Quotation changes, each encompassing one or
more sub-rules (``quote instability rules''), to determine whether the
System should trigger the CQI. When a quote instability rule is
``active,'' as described below, the CQI will trigger when the rule is
``true'' thus indicating a potential crumbling quote. These quote
instability rules are grouped into the following four categories:
1. Disappearing Bids/Offers: Four separate rules look at when the
Signal Exchanges \18\ fall off the best prices.
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\18\ See infra note 20 and accompanying text.
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2. Quote Size: Two separate rules look at size imbalances between
buys and sells at the best price on the Signal Exchanges.
3. Locked or Crossed Markets: This single rule looks for locked and
crossed conditions at a Signal Exchange.
4. Quotation Price: Two separate rules evaluate changes in the best
prices on the Signal Exchanges.\19\
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\19\ See Notice, supra note 3, at 62905-07 for the Exchange's
detailed discussion of the proposed quote instability rules.
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Overall, there are several notable differences between the
Alternative CQI Calculation and the Current CQI Calculation. First, the
Alternative CQI Calculation expands the number of exchange protected
quotes (i.e., Signal Exchanges) that are evaluated by the System from
eight exchanges to eleven.\20\ In addition, the Alternative CQI
Calculation can activate crumbling quote protection for one or both
sides of the market (e.g., it can determine a crumbling quote to exist
on the bid side and, while that crumbling quote protection is active,
separately and concurrently determine a crumbling quote to exist on the
offer side), whereas the Current CQI Calculation only activates the CQI
for one side of the market at a time.\21\ Further, under the Current
CQI Calculation, the Exchange only analyzes the relevant prices at the
Signal Exchanges, whereas the Alternative CQI Calculation will also
take into account quotation sizes at the eleven away exchanges under
the Quote Size rules.
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\20\ The additional Signal Exchanges are MIAX PEARL, LLC, MEMX
LLC, and Nasdaq Phlx LLC.
\21\ More specifically, the current rule text reads as follows:
``Only one determination may be in effect at any given time for a
particular security. A new determination may be made after at least
200 microseconds has elapsed since a preceding determination, or a
price change on either side of the Protected NBBO occurs, whichever
is first.'' The new rule text for the Alternative CQI Calculation
reads: ``Quote Instability Determinations are made separately for
the Protected NBB and Protected NBO, so it is possible for zero, one
or both of the Protected NBB and Protected NBO to be subject to a
quote instability determination concurrently.'' Additionally, the
revised rule text states that ``[a] determination that the Protected
NBB for a particular security is unstable does not impact the
System's ability to determine that the Protected NBO for that same
security is also unstable, and vice versa.''
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In addition, the Alternative CQI Calculation increases the minimum
time period between CQI determinations (i.e., when a new CQI can
trigger during the two millisecond ``on'' period). Currently, the
System will keep the CQI in effect for two milliseconds, unless, after
200 microseconds, a new determination is made by the System that the
quote continues to crumble, in which case the CQI will extend for
another two milliseconds from that point. Under the Alternative CQI
Calculation, the CQI will also remain in effect for two milliseconds,
but a determination to extend the CQI cannot be made until at least 250
microseconds have passed. The Exchange states that
[[Page 75101]]
CQI triggers in extremely rapid succession are unnecessary to
continuously restrict discretion across successive NBBO changes, and
that increasing what it refers to as the CQI ``cooldown period'' from
200 microsecond to 250 microseconds before the System can make another
quote instability determination will reduce the technical processing
burden on the System.\22\
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\22\ See Notice supra note 3, at 62907.
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In general, the Exchange explains that the current quote
instability calculation ``utilizes a logistic regression model with
multiple coefficients and variables that must exceed a pre-defined
threshold in order for the System to treat the quote as unstable.'' The
Exchange characterizes the new Alternative CQI Calculation as a
``rules-based model'' that ``incorporates and expands on the existing
approach.'' \23\
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\23\ See id. at 62905.
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The Alternative CQI Calculation also uses the concept of an
activation value (``Activation Value'') for each of the new quote
instability rules. As explained in more detail in the Notice, the
Activation Values and corresponding thresholds are ``intended to
optimize the overall accuracy of the quote instability determinations
by providing a mechanism to turn off a particular rule when market
conditions are such that it is relatively less accurate in predicting a
crumbling quote.'' \24\
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\24\ See id. at 62907.
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Specifically, the Activation Value is a function generally of the
number of times the quote moves to a less aggressive price within the
two milliseconds ``on'' timeframe following the time the rule was
``True'' (i.e., to assess whether the rule correctly predicted a
crumbling quote) and the total number of times the rule was True.
Whenever the Activation Value for a given quote instability rule
exceeds a fixed predetermined activation threshold specific to that
rule (the ``Activation Threshold''), the rule is active (i.e., it is
eligible to trigger a quote instability determination when True).
Finally, the proposal sets forth several conforming changes
throughout IEX Rule 11.190(b) to establish that Users may utilize one
of the two crumbling quote calculations for P-Peg, D-Peg, and C-Peg
orders. The Exchange also proposes to amend IEX Rule 11.190(b)(7),
which sets forth the Exchange's D-Limit order type, to make clear that
a User may only use the Current CQI Calculation when entering a D-Limit
order.\25\
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\25\ Unlike the non-displayed P-Peg, D-Peg, and C-Peg order
types, D-Limit orders can be displayed or non-displayed.
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III. Discussion and Commission Findings
After careful review, the Commission finds that the Exchange's
proposal is consistent with the requirements of the Exchange Act and
the rules and regulations thereunder applicable to a national
securities exchange.\26\ In particular, the Commission finds that the
proposed rule change is consistent with Sections 6(b)(5) \27\ and
6(b)(8) \28\ of the Exchange Act. Section 6(b)(5) of the Exchange Act
requires that the rules of a national securities exchange be designed,
among other things, to promote just and equitable principles of trade,
to remove impediments to and perfect the mechanism of a free and open
market and a national market system and, in general, to protect
investors and the public interest, and not be designed to permit unfair
discrimination between customers, issuers, brokers, or dealers. Section
6(b)(8) of the Exchange Act requires that the rules of a national
securities exchange not impose any burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Exchange
Act.
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\26\ In approving this proposed rule change, the Commission has
considered the proposed rule's impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
\27\ 15 U.S.C. 78f(b)(5).
\28\ 15 U.S.C. 78f(b)(8).
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In its filing, the Exchange explains that adding three more Signal
Exchanges and also using quotation size data in addition to quotation
price data is designed to increase the predictive power and accuracy of
the quote instability calculation.\29\ Adding additional reference
exchanges and considering quoted size in addition to quoted price
appear reasonably designed to contribute to the functioning of the
crumbling quote indicator consistent with its original design and
purpose.
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\29\ See Notice, supra note 3, at 62908.
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Further, the Exchange states that the use of Activation Thresholds
for the Alternative CQI Calculation is designed to optimize the
frequency and accuracy of the quote instability calculation by enabling
IEX to utilize a broader array of rules that may be predictive of a
crumbling quote in certain market conditions but not others.\30\
Specifically, IEX states that the proposed activation values and
thresholds are designed to ``enable broader coverage while controlling
for overall accuracy of the quote instability determinations by
providing a mechanism to turn off a particular rule when market
conditions are such that it is relatively less accurate in predicting a
crumbling quote'' where certain rules with a higher potential to be
less accurate have a higher activation threshold before they become
active.\31\ The Exchange states that it expects the Current and
Alternative CQI Calculations to continue to be ``on'' for only a small
portion of the trading day.\32\ The Exchange further explains that it
designed the Alternative CQI Calculation in response to feedback from
Users of P-Peg, D-Peg, and C-Peg orders, some of which expressed a
desire for additional coverage.\33\ If allowed to use the Alternative
CQI Calculation, IEX expects that some Users may begin to enter more
and larger sized pegged orders on the Exchange.\34\
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\30\ See id. at 62907.
\31\ See id. at 62909.
\32\ See id.
\33\ See id. at 62908.
\34\ See id. at 62909.
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While the Exchange acknowledges that the Alternative CQI
Calculation may trigger more frequently than the current version, it
has developed a reasonable method, through the Activation Values and
Activation Thresholds, to cause the new rules to be used in those
market conditions in which the Exchange expects them to be more
accurate in predicting a crumbling quote. To the extent Users see their
execution quality for non-displayed orders improve when they use the
Alternative CQI Calculation, they may be incentivized to post more non-
displayed pegged orders on the Exchange, which in turn will benefit
liquidity seeking investors especially during most of the day when the
quote is stable and those pegged orders are offering aggressive price
improvement to those investors.
Based on the foregoing, the Commission believes that the proposal,
including the Alternative CQI Calculation, is appropriately and
narrowly tailored to provide a reasonable mechanism for Users of non-
displayed peg orders on the Exchange to protect their orders from
adverse selection during limited periods of time in specific market
conditions. Further, the proposed Alternative CQI Calculation is
transparent and fully-disclosed in the rules of the Exchange. While the
Exchange uses the phrase ``price discretion'' to describe the operation
of the crumbling quote functionality, the Exchange itself retains no
discretion to deviate from the confines of the rule, as the rule
contains the entirety of the parameters under which the Alternative CQI
Calculation
[[Page 75102]]
will operate. The Exchange's proposal does not otherwise amend any
functionality of the affected peg order types.
In addition, because the Alternative CQI Calculation will activate
without further action from the User, all Users will benefit equally
regardless of their technological capabilities and ability to take
action within a short prescribed period. To the extent the Alternative
CQI Calculation is successful in incentivizing more firms to post non-
displayed peg orders on the Exchange, it will contribute to liquidity
that all market participants can access and increase opportunities for
investors to receive improved prices on their liquidity taking orders.
Accordingly, the proposal promotes just and equitable principles of
trade, removes impediments to and perfects the mechanism of a free and
open market and a national market, and, in general, protects investors
and the public interest.
Finally, the Alternative CQI Calculation cannot be used to trigger
the repricing of any displayed orders, specifically, the D-Limit Order
type. As such, market participants seeking to execute against displayed
liquidity on IEX, including protected quotes, will not be adversely
affected by the addition of the Alternative CQI Calculation to the
Exchange's rules because use of the Alternative CQI Calculation is
limited to the P-Peg, D-Peg, and C-Peg order types.
For the reasons discussed above, the Commission finds that the
proposal will not impair access to quotations and is narrowly tailored
to not impose any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Exchange Act, and is
reasonably designed to remove impediments to and perfect the mechanism
of a free and open market and a national market system and, in general,
protect investors and the public interest. Accordingly, the Commission
finds the proposed rule change to be consistent with the Act, including
the requirements of Section 6(b)(5) and Section 6(b)(8) of the Act.
IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Exchange Act,\35\ that the proposed rule change (SR-IEX-2022-06), be,
and it hereby is, approved.
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\35\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\36\
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\36\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2022-26533 Filed 12-6-22; 8:45 am]
BILLING CODE 8011-01-P
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