REG NMS Cheat Sheet
Trade-Through Rule
Essence of the Rule:
The SEC has proposed two alternatives to the Trade-Through Rule. The first would require the best bids and offers - the top-of-book - to be displayed in all markets. The second proposal would mandate that several levels of quotes - known as depth-of-book (DOB) - be displayed across all markets. The SEC will vote early this year to determine which alternative it will pursue.
The Trade-Through Rule, to be renamed the Order Protection Rule, aims to create a level playing field for all investors by providing equal access to prices and mandating that trades be executed at the best price. If the best price is a displayed price, it cannot be "traded through," or, in other words, it cannot be ignored. Orders that are in reserve, or hidden, are not protected and can be ignored, even if the prices are better than the displayed price. Manual quotes - those that are not published via an electronic trading system - also can be ignored. The proposed Order Protection Rule applies to exchange-listed stocks, as does the existing Trade-Through Rule, but also adds Nasdaq-listed securities to its jurisdiction. In addition, the new proposal also will govern block trades and smaller orders, often called 100-share orders, which can be bypassed under the existing rule.
Impact
Sell Side:
Brokers will need to update their order-management systems to conform to the requirements of the reproposed Trade-Through Rule, such as executing intermarket sweep orders, which route orders to multiple marketplaces to execute them against liquidity at several price points. Every direct-access trading system and smart-order-routing system will need to be adjusted to comply.
The proposed rule jeopardizes the role of the NYSE's floor brokers, who are given large institutional orders to work in reserve; under the new rule, hidden reserves - better-priced orders that are not exposed - will not be protected.
The proposal would prevent brokers from committing capital outside the spread and, if an exemption for block trades is not made, agency block trading will decline and the market will move toward slicing orders via algorithms.
Buy Side:
The Trade-Through, or Order Protection, Rule could give incentive to the buy side to display its limit orders - orders stating a specific price to buy or sell - and provide more liquidity to the market. Instead of asking a broker for a capital commitment, a firm could divide the order and use the intermarket sweep to hit the depth-of-books of multiple markets. But the sweeps may slow down the market, preventing the buy side from getting immediacy. Conversely, institutions may not want to show their hands, thus scaring liquidity out of the market and seeking refuge in crossing networks like Liquidnet, POSIT and Harborside+ or the ATS Pipeline. These ATSs would be covered by Reg NMS only if their volume in a particular security surpasses a predetermined threshold (see Access Rule).
ECNs and Exchanges:
The Nasdaq market and the ECNs currently have the technology to publish DOB prices, but they will face more regulatory restrictions. This would hurt the NYSE, whose hybrid-market plan does not have DOB features.
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