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Cboe Debuts a Liquidity Provider Protection Feature on Equities Exchange

Posted by Metals Corporate on

Cboe Debuts a Liquidity Provider Protection Feature on Equities Exchange

By John McDonald

Cboe, one of the world’s largest exchange holding companies, has filed a new investor protection tool with the U.S. Securities and Exchange Commission (SEC).

The company calls the tool its “Liquidity Provider Protection feature,” or LP2, and announced in mid-June of this year that the tool is “designed to enhance liquidity and enable market makers to make better markets in stocks traded on the exchange.”

The filing outlined the protection tool, which has not yet met with regulatory approval. If LP2 is approved, it would appear on the Cboe EDGA Equities Exchange, abbreviated simply EDGA, and would stall liquidity-taking orders for four milliseconds before trading with resting orders on the order book.

Cboe explained the new feature will “enable liquidity providers to take more risk and quote tighter spreads with greater size by giving them sufficient time to re-price their resting orders before opportunistic traders can trade with them at stale prices.”

In the event that LP2 meets with regulatory approval and takes its place on the EDGA, it “would be the first-ever delay mechanism in the U.S. equities market to enhance market quality by promoting price-forming, displayed liquidity,” observed the company in a formal press statement.

At present, most delay mechanisms in use on U.S. equities exchanges do not provide protection to market makers. Cboe considers these participants to play “a critical function…in price discovery” and, executive vice president and co-head of markets division at Cboe Bryan Harkins said, would “deemphasize speed, measured in microseconds and nanoseconds, as a key to trading success.”

In the SEC filing, the company proposed that this de-emphasizing of micro-second trading will ultimately improve market quality, stabilize the market structure, and “benefit all market participants that choose to trade on Cboe EDGA.”

The filing also states that the current market has a perilous potential “for trading at stale prices,” which increases risks for firms providing liquidity to the market.

Cboe went on to say that this risk “causes liquidity providers to enter quotes that are wider or for a smaller size than they may otherwise be willing to trade.”

A mere four-millisecond delay, provided by the LP2, would “negate the advantages that opportunistic trading firms that use the latest microwave connections have over liquidity providers using traditional fiber connections,” the Cboe team wrote in the filing.

This would level the playing field, they added, because the proposed delay would not apply to non-executable orders that would add liquidity and market participants would be able to interact with resting orders without being subject to the delay mechanism.

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