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US Equities Microstructure

· 4 min read
Sanjeev Sarda
Sanjeev Sarda
High Performance Developer

A TLDR note on US equities microstructure. Also covers Reg NMS 2.0.

Equities

How Are US Equity Markets Structured?​

The US equity markets are composed of exchanges, ATS and dark pools as well as large scale internalizors.

If we look at where volumes are, most of the flow is internalized before it hits exchanges - especially low USD value, low toxicity retail flow.

If it does hit an exchange, the main ones are NYSE, CBOE and Nasdaq.

With highly liquid instruments like the SPY, there can still be some exchange volume:

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Source: ChartExchange

But that distribution can vary day to day and on a per name basis:

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Source: ChartExchange

I can't find a good example right now, but there are also some super low liquidity names where some exchanges like MIAX can really dominate.

Dark Pools/ATS​

Dark pools are private venues that don't display quotes, allowing market participants to trade large blocks discretely. Dark pools must report trades to FINRA's TRF (Trade Reporting Facility) and are registered under Regulation ATS with the SEC.

These pools are mostly operated by large brokers and they account for single digit percentages of US equity volumes. As each broker has a slightly different client base, they typically cater to different kinds of flow (client, broker dealer) and they also vary in their level of support for block trading.

Wholesale Internalizers​

These players also report into the TRF and are basically internalizing retail flow from the large retail/introducing brokers, usually under a payment for order flow (PFOF) based relationship. Very much an economies of scale and volume game.

The largest players in the space by far are Citadel and Virtu (over 75% of retail flow) with Susquehana, 2Sigma and Jane Street also doing good volumes.

OTC Markets/Pink Sheets​

This is a market that provides pricing and liquidity for OTC securities - it's operated by a company called OTC Markets Group and was formally the National Quote Bureau or Pink Sheets.

Operates quite a "unique" microstructure and can dominate when it comes to volumes in certain classes of equities like depository reciepts.

Venue Locations​

The equities triangle between Mahwah, Secaucaus and Carteret is where most of the action occurs.

  • Mahwah - Nyse, SIP for Tapes A and B
  • Carteret - Nasdaq, Tape C SIP
  • Secaucus - CBOE, IEX

There are obviously lots of other venues and players in those locations, like ICE in Mahwah.

What is Reg NMS?​

The original Reg NMS from 2005 created the NBBO, SIP and was about increasing trading venue competition, transparency and best-ex.

It was implemented through a set of rules:

  • Rule 611 - Order Protection Rule. You must route to the venue with the best price.

  • Rule 610 - Access Rule. Capped the access fees that exchanges can charge.

  • Rule 612 - Sub penny rule. Sets the minimum ticksize for all stocks above $1 to be 0.01 cents.

  • Rules 601-603 - Market data rules. Created the SIP, the Securities Information Processor, a consolidated public tape with some limitations.

What is Reg NMS 2?​

This is the proposed Equity Market Structure Reform which the SEC are looking at.

It features:

  • Order competition rule - introducing very short RFQ style auctions that creates order by order competition before the order can be wholesale internalized.

  • Odd lots - will now be included in the SIP

  • Tick size reforms - variable/smaller tick sizes for tighter spreads and more opportunity for price improvement vs a 1 tick spread

  • SIP - Include depth of market (and did I mention odd lot quotes?)

  • Reporting - More TCA and demonstrating execution quality burden for brokers, better reporting for investors

https://otctransparency.finra.org/otctransparency/AtsIssueData