Changes in Island ETF Business
Message to Island Subscribers
September 19, 2002
Thanks to you, the subscriber, Island has become the largest and most liquid marketplace for trading Exchange Traded Funds such as QQQ. Given the efficiency and size of the Island market, our order book data has become a critical piece of information for any trader active in QQQ and its component securities. Unfortunately, due to recent regulatory actions taken by the U.S. Securities and Exchange Commission, Island will no longer be able to disseminate its order book information in QQQ, DIA, SPY, SMH and MKH beginning on September 23, 2002. (For more information on the specific impacts of this action, please visit FAQ).
Until recently, the SEC had given Island the choice of whether to participate in the National Market System by providing what was effectively an exemption from complying with certain SEC rules. The SEC, however, is withdrawing this exemption, and has given Island a Sept. 23 deadline for participation in the NMS. As you know, Island has always shared its order book information, both with subscribers over ITCH and with the general public through BookViewer, and Island even permits unfettered re-distribution of its market data. Island has long sought to have its order book in listed securities included in the Consolidated Quotation, and has put forward several suggestions to achieve this goal. Unfortunately, under the current regulatory structure, there is no mechanism for including Island’s order book information in the Consolidated Quote without negatively impacting execution quality.
Over the coming months, the issues surrounding this change will be the subject of industry meetings hosted by the SEC. As always, Island will consult with its subscribers to determine what will best serve their needs. Moreover, Island looks forward to working with the SEC and the U.S. Congress to revise the current regulatory structure so that Island can again disseminate its subscriber order information in all securities.
To assist us in this effort, we request that you sign the Island Testimonial (PDF, 5.4k) (if you have not already done so) and fax back to 212-231-5069, or send us your own letter regarding your ability to use Island to obtain quality executions. Island is committed to working on your behalf to operate the most efficient, liquid and transparent market possible. We look forward to working with you in the months ahead.
BACKGROUND:
Until recently, the SEC had given Island the choice of whether to participate in the National Market System by providing what was effectively an exemption from complying with certain SEC rules. The SEC, however, is withdrawing this exemption, and has given Island a Sept. 23 deadline for participation in the NMS. (Island will be sending out a separate notice discussing the changes it will make to comply with SEC rules). For the past four years, Island has expressed its concerns to the SEC and Congress about forcing electronic agency markets to participate in the National Market System, and to do so in such a way that eliminates their key competitive advantages. Regulation should never be applied in such a way as to give one market type an advantage over another. In particular, Island has voiced concerns over rules that would effectively preclude Island subscribers from displaying orders on Island that would lock or cross another market’s quote. For example, if the American Stock Exchange is offering shares of QQQ at 50 and an Island subscriber submits an order to buy at 50.01, Island is effectively prevented from displaying that subscriber’s order. Since a key attribute our subscribers demand is instantaneous price discovery, this rule impedes the ability of our subscribers to trade efficiently. This prohibition is particularly burdensome to subscribers given the response times of the traditional floor-based models.
Another troubling rule applicable to participants in the National Market System is known as the trade-through rule. The trade-through rule effectively prohibits a participant in the National Market System from trading at a price that is inferior to a price quoted by another market. For example, if the American Stock Exchange is offering shares of QQQ at 50 and an Island subscriber submits an order that would cause an execution at 50.01,Island would be required to reject that order. As above, given the response times of
traditional floor-based models, Island believes this rule artificially restricts efficient price discovery and trading.
ISLAND’S SUCCESS IN TRADING ETFs:
Largely due to these two rules, Island decided that the best way to provide subscribers the most efficient trading environment was by not participating in the National Market
System. Again, our decision not to participate in the NMS at the time was supported by an exemption from the SEC. Our decision has been vindicated by Island’s unique and
historic success in trading the QQQs: last October, Island surpassed AMEX to become the primary market for the most liquid security in the world; Island now often accounts
for more than 40% of the daily total share volume in the QQQ and more than 30% in DIA and SPY. Island’s efficient trading environment has also spawned new trading strategies.
The overall average daily volume in QQQ has soared 300% since the introduction of Island from approximately 27 million shares per day in 2000 to approximately 90 million
shares per day to date in 2002.
As a result of this success, the SEC has determined that Island subscriber orders must now be subject to the rules of the National Market System. In response to Island’s
concerns about regulatory issues surrounding the trade-through, the SEC recently approved a de minimis trade through exemption of 3 cents. In other words, National
Market System participants are no longer prohibited from trading- through another market’s quote if the trade-through is three cents or less away. While the de minimis
trade through exemption is a step in the right direction, the effective prohibitions against the display of orders that would cause a locked or crossed market remain. Although
Island is generally encouraged by the SEC’s recent action, it unfortunately falls short of what’s needed to avoid significantly disrupting the efficiency of Island’s market.
HEARING FROM OUR SUBSCRIBERS:
One rationale to justify the continuance of the rules described above is the claim by some of Island’s critics that Island subscribers are not receiving quality executions. In otherwords, some argue that because some executions on Island occur at prices inferior to the
prices advertised by traditional floor-based models, Island subscribers are unwittingly receiving inferior executions. Island rejects the notion that its subscribers do not best
understand their interests, and should be forced to route orders to the traditional floorbased markets and otherwise need outside assistance to determine what is best execution
of their own orders.
Therefore, Island believes it is important to hear directly from you. If you disagree with those that claim you receive inferior executions on Island when trading ETFs,please take a moment to read, sign and return the attached “Island Testimonial.”
We hope you agree that Island is an extremely valuable tool for trading ETFs.
Thank you for your continued support. Island pledges to continue to represent your interests and provide you with the most efficient, lowest cost trading platform possible.
As always, please feel free to contact us directly if you wish to discuss this or any issue
further. |
