[17909]
August 19, 2004
TO: EQUITY MARKETS ADVISORY COMMITTEE No. 37-04
SEC RULES COMMITTEE No. 71-04
RE: NYSE PROPOSED RULE CHANGE RELATING TO THE IMPLEMENTATION OF A
HYBRID MARKET
The Securities and Exchange Commission has issued a notice of the filing of a proposed
rule change by the New York Stock Exchange to implement enhancements to its existing
automatic execution facility, NYSE Direct+, in order to create a “hybrid” market.1
Comments on the proposed rule change must be received by the SEC no later than
September 7, 2004. If you have any questions regarding the proposal or any comments you
would like the Institute to consider including in its comment letter on the proposed rule
change, please contact Ari Burstein by phone at 202-371-5408 or by e-mail at
aburstein@ici.org by August 27.
A. Treatment of Orders and Quotes in Hybrid Market
Under the NYSE’s proposal, market orders and immediate or cancel (“IOC”) orders
would be permitted to be automatically executed on the Exchange. Similarly, limit orders to
buy priced at or above the Exchange’s published offer and limit orders to sell priced at or below
the Exchange’s published bid (“marketable limit orders”) would be automatically executed,
whether or not such orders are designated for automatic execution. Market orders not
designated for automatic execution would be executed in the auction market as would non-
marketable limit orders, even if designated “auto ex.” The NYSE also would create a new order
type called an “Auction Limit” or “AL” order. An AL order would provide the opportunity for
price improvement and would be required to be designated as such when entered into the
market. Finally, all quotes would be subject to automatic execution, unless designated
otherwise. Non-auto-executable quotes also could be generated electronically when a
“Liquidity Replenishment Point” (“LRP”) (discussed below) is reached or by the specialist
“gapping the quotation” due to an order imbalance.2 In such a case, a transaction, update of the
1 Securities Exchange Act Release No. 50173 (August 10, 2004), 69 FR 50407 (August 16, 2004) (“Release”). The
NYSE’s proposal can be found on the SEC’s website at http://www.sec.gov/rules/sro/nyse/34-50173.pdf.
2 The Release states that the purpose of a gapped quotation would be to disseminate the existence of an order
imbalance and minimize short-term price dislocation associated with such an imbalance by allowing appropriate
2
quote by the specialist, or a timer-generated quote update, would resume automatic executions
and autoquotes.
B. “Sweeping” the NYSE Display Book
The NYSE’s proposal provides for the unfilled balance of any “auto ex” market order or
marketable limit order to “sweep” the book, automatically executing until it is filled, its limit
price, if any, is reached, or an LRP is reached. Bids and offers on the Display Book between the
displayed bid or offer and the sweep “clean-up” price would receive price improvement at the
“clean-up” price. Any balance remaining after the order reaches its limit price, if any, or an LRP
is reached, would remain on the book for handling in the auction market where it would
become a bid or offer at its limit price or the LRP price, whichever is reached first. If executed at
the price at which it is bidding (offering), the balance would have priority; if executed at a
different price (within the parameters of its limit, if any), the balance would trade on parity with
the crowd.
C. Liquidity Replenishment Points
The NYSE is proposing to implement two types of LRPs - a price-based LRP and a
momentum-based LRP. The price-based LRP would be a minimum of five cents from the
Exchange’s best bid or offer, rounded to the next nearest nickel. A specified price movement
over a specified period during a trading session would trigger the momentum-based LRP.3 In
either case, when an LRP is reached, the automatic execution functionality on the Exchange
would “shut off” and the quotation would not be available for automatic execution and would
be designated as such. Autoquote would be suspended, although cancellations of orders would
be permitted. When an LRP is reached, the specialist, crowd, and off-floor market participants
also could enter orders to replenish liquidity on either side of the market.4
D. Interaction with Orders and Quotes in Other Markets
Under the proposed hybrid market plan, ITS commitments to trade sent to the NYSE
from another market center because the Exchange’s published bid or offer is the national best
bid or offer (“incoming” ITS commitments) would be automatically executed to the extent of the
time for the entry of offsetting orders or the cancellation of orders on the side of the imbalance. The Release further
states that an imbalance could occur because of a sudden influx of orders on the same side of the market, the entry of
one or more large-sized order(s) with little or no offsetting interest, or when a member proposes to effect a one-sided
block transaction at a significant premium or discount to the prevailing market.
3 The Release states that the precise parameters for the momentum-based LRP are currently under review and would
be identified at a later time and submitted as an amendment to the proposed rule change.
4 When an LRP is reached and no residual remains, or a residual remains and it is not capable of trading at a price
above (in the case of a buy order) or below (in the case of a sell order) the LRP, autoquote would resume as soon as
possible, but in no more than five seconds, unless in that time, orders came in that locked or crossed the market. If an
LRP is triggered and a residual capable of trading at a price above or below the LRP remains, but does not lock or
cross the market, autoquote would remain disengaged, and automatic executions could not occur until the specialist
trades or requotes the market. However, autoquote and auto executions would resume in any event in no later than
28 seconds. Where a residual remains and it is capable of trading above (below) an LRP and it locks or crosses the
market, autoquote and auto executions would not be available until a trade occurs or the specialist requotes the
market.
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volume of the Exchange’s published best bid or offer, and any unfilled balance would be
automatically cancelled. Where the national best bid or offer is published by another market
center in which an automated execution is immediately available, or such bid or offer is
otherwise protected from a trade-through and the specialist has not systemically matched the
price associated with such bid or offer, the Exchange would automatically route to the other
market center the portion of a market or marketable limit order that would satisfy the better-
priced bid or offer (“outgoing” ITS commitments).
E. Role of Specialists and Floor Brokers in Hybrid Market
Under the NYSE’s proposal, specialists would have the ability to systemically
supplement the quote, determine price points outside the Exchange’s best bid and offer to
which they want to provide liquidity by bidding or offering on behalf of the dealer account,
facilitate a single-price execution at the bid or offer price, and systemically match outgoing ITS
commitments. The “specialist interest file” would not be publicly disseminated unless it is at
the Exchange’s best bid or offer price. Specialist interest that establishes the best bid or offer
would be entitled to priority with the crowd at that price for one trade. Specialist interest at
other prices would yield to agency orders and the broker agency interest file (discussed below),
except that once orders on the Display Book are filled, specialists could trade on parity with the
crowd, including broker agency interest.
Brokers would have the ability to place within the Display Book an “agency interest file”
at varying prices at or outside the quote with respect to orders the broker is representing. This
interest would not be publicly disseminated unless it is at the Exchange’s best bid or offer.
Broker agency interest would have priority if it establishes the best bid or offer and would be on
parity with other orders at its price. The broker’s agency interest also could serve to improve
the price of a sweep order. The broker would be able to place agency interest in only one crowd
at any given time and would be required to cancel his or her agency interest file when leaving
the crowd. When the broker wants to trade as part of the crowd on the same side and at the
same price as his or her agency interest, the broker would be required to add to the existing
agency interest or cancel any agency interest at that price before verbally trading in the crowd.
If the broker leaves the crowd without canceling his or her agency interest file and a trade
occurs involving such interest, the broker would be held to that trade.
Ari Burstein
Associate Counsel