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Feb 27 A bustling financial exchanges sector has thrust securities regulations known as Reg NMS into the spotlight as both shareholders and traders focus on how the rules, which take effect this year, will affect the U.S. equity trading business.
The following terms explain some concepts behind Regulation NMS, for National Market System.
Order Protection Rule: Referred to as the "Trade-Through Rule," this is the most anticipated and controversial aspect of Reg NMS. It requires that automated, or "fast" markets obtain the best available price for customers. A "trade-through" occurs when an order is executed that ignores superior quotes immediately accessible elsewhere. Under Reg NMS these superior quotes would be protected.
Market Date Rules: Likely the most significant aspect of Reg NMS after the trade-through rule, these rules determine how revenue is allocated from fees paid by broker-dealers for market data. Reg NMS divides revenue between markets based on both the number of completed trades and stock price quotes posted at the best price. Prior rules divided revenue based on the number of shares executed, giving an incentive for markets to break orders into smaller increments for which they could receive additional data revenue in a scheme the SEC calls "trade shredding."
Access Rule: Designed to create fair and open access to stock price quotations across venues, this rule promotes connecting markets through private links and caps fees charged for these linkages.
Sub-Penny Rule: Reducing variation between quotes, this rule establishes pricing increments of no less than one penny unless the price of the quote is below $1.00 per share.
Intermarket Trading System: A centralized system established by the U.S. Securities and Exchange Commission in 1978 to link exchanges and display national quotes.
Regional exchanges: Small and private, these exchanges traditionally focused on a geographic region. Analysts say the trade-through rule should increase their market share. Large broker-dealers like Citigroup (C.N) have invested in regionals such as the Philadelphia Stock Exchange.
Options exchanges: Exchanges that handle options have been entering equities trading. International Securities Exchange ISE.N, the first U.S. electronic options exchange, recently launched a stock market that may benefit from the mandate under the new rules that automated trades be executed at the best available price.
Alternative trading system (ATS): Often backed by broker-dealers, an ATS provides alternatives to traditional exchanges. In 1998 the SEC adopted rules for ATS regulation, which include electronic communication networks (ECNs) and block crossing networks.
Electronic communications network (ECN): An ATS that automatically matches buy and sell orders among subscribers. After a period of intense competition following Order Handling Rules adopted by the SEC in 1997, large ECNs were acquired by exchanges such as the Nasdaq Stock Market's (NDAQ.O) 2005 purchase of INET ECN.
Block crossing network: An ATS that handles large chunks of stock for institutions. An established block crossing network is private equity-backed Liquidnet.