Use consolidated quotes to reconstruct price range o

1
Cheating the System - Surveilling Equity Trading

• By Yeshanth Gunewardena
• Advisor Professor J. Breecher
• Assisted by Kaskad Tech, Boston Stock Exchange,
  Professor M. Tamarkin, Professor J. Sternberg

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Introduction

• In the US securities trading is conducted
  electronically using Electronic Communication
  Networks (ECNs).
• The US National Market System consists of 10
  Exchanges
• NYSE, BSE, CHX, PHLX, AMEX, NASDAQ
• ITS NMS Linkage Plans
• Facilitates trading between members of the NMS.
• RegNMS - SEC Regulatory Policies
• Governs electronic trading in NMS, promote fair
  trading
• Four primary policies - (1) Sub-penny Pricing
  Rule , (2) Access Rule, (3) Order Protection Rule
  (4) Market Data Rule

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Background- Order Protection Rule

• Aims to create a level playing field by
  providing equal access to prices and mandating
  that trades are executed at the best price
• Provides investors with protection against
  trading through of their limit orders.

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What is Trade Through?

• A trade through occurs when one trading center
  executes an order at a price that is inferior to
  the price of a quotation, often representing a
  limit order, displayed by another trading center.

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Example
BSE Bid 91.12 BSE Ask 91.15
NYSE Bid 91.11 NYSE Ask 91.13
Time
PCX Bid 91.10 PCX Ask 91.14
AMEX Bid 91.11 AMEX Ask 91.14
NYSE 100 91.11
Best Price Range 91.12 - 91.13
BSEs NBB for 91.12 was traded through by an
inferior order at NYSE at 91.11.
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Order Protection Rule contd

• Implications
• Scope
• Automated quotations and limit orders of NMS
  stocks
• All trading centers including exchanges and
  participants (broker dealers etc.)
• Actions
• Trading centers must design its
  procedures/policies to prevent trade thoughs and
  provide best execution to customers
• Surveil trading activities to ascertain the
  effectiveness of these policies.

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Project Overview

• Focus Boston Stock Exchange.
• Original Goal Develop a tool to allow the
  detection of trade through violations.
• Data Requirements Consolidated quotes and Boston
  trades (ideally, real-time).

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Initial Challenges Project Revisions

• Challenges
• Cost of obtaining trades and quotes data.
• Existence of another surveillance system
• Resolution
• Use delayed information limit to specific
  equities.
• Create a tool to replay trade through
  occurrences.
• Application Justify trades to clients and
  regulatory organizations after the fact.

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Detection Methodology

• Use consolidated quotes to reconstruct price
  range or National Best Bid/Offer(NBBO).
• Read incoming Boston trades and verify the trade
  is not exempt from the regulation.
• Compare trades to NBBOs within a time window
  before the trade.
• Verify the trade occurred within price range. If
  not, record the trade through and notify
  administrator.

Trade Time
Trade Time - Fixed Period
NBBO Timeline
Relevant Time Window
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My Solution?

• Renegade Equity Surveillance Replay!

Replay quotes/trades over a time period, recreate
price range, and detect trade through scenarios.
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Features

• Primary features
• Replay quotes and trades over a user specified
  time period.
• Uses quote to create a chronological stream of
  NBBO.
• Analyze Trades for Violations.
• Violation Listing and computation of resultant
  monetary loss to the exchange/customer.
• Additional features
• Easy Configuration.
• GUI interface.
• Comprehensive Logging Mechanism.
• Distributed Architecture
• Platform Independence

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Overview of the System
Read Quotes
Construct NBBO Stream
Analyze Data
View Results
Data Source Database
Database
Database
Security Admin
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Data Sources
Construct NBBO
Read Quotes
Analyze Data

• Quotes and trades originating from SIP and SIAC
  market data feeds.
• SIP - Securities Information Processing
• SIAC - Securities Industry Automation Corp
• Replica of Oracle Database maintained by BSE
  containing historical quotes and trades.
• Data handling done by DatabaseHandler module.

Database
Database Handler
Data
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Streaming NBBO Data
Read Quotes
Construct NBBO
Analyze Data
View Results

• Performed by Streamer mechanism
• Read quotes from the database
• Identify quotes which affect NBBO
• NAT_NBBO_IND Field
• Create new NBBO for each quote - contains price,
  size, time and participant
• Enter encapsulated NBBO data into stream

Streamer
Database Handler
NBBOs
Quotes
NBBO Stream
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Analyzing Data
Read Quotes
Construct NBBO
Analyze Data
View Results

• Performed by the Analyzer mechanism
• Read data from the NBBO stream
• Read trades from database
• Analyze and compare
• Record Violations - ExceptionHandler

Database Handler
Trades
Analyzer
Violation Info
Exception Handler
NBBOs
NBBO Stream
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Recording Violations
Construct NBBO
View Results
Analyze Data

• Performed by ExceptionHandler module
• Calculate value lost to investor as a result of
  the violation.
• Record violation and necessary identification
  info in database.

Database
Violation Info
Analyzer
Violation Info
Exception Handler
Database Handler
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View Results
Read Quotes
Construct NBBO
Analyze Data
View Results

• Graphical User Interfaces
• Operation Console
• Configuration windows
• Violations Display

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Demonstration

• Scenario
• Equity VZ - Verizon Wireless
• Start Date/Time Dec 21 2006 1500
• End Date/Time Dec 21 2006 1530
• Exchange B - BSE
• Expected result 1 violation

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Performance Features

• Each trading day will produce about 150 - 200
  million messages on all equities alone (not
  including options)
• Each message size ranges from 100-800 bytes
• The Renegade software is optimized to handle
  large data volume.
• Scalable stream sizes
• Optimized code to reduce resource usage
• Database optimization using Oracle TopLink
  Client-side caching
• Optional logging mechanism to increase processing
  speed

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Who can uses of this software?

• RegNMS regulations became effective on August 31,
  2006
• All trading centers are required to comply with
  policies and acquire necessary software and
  hardware capabilities.
• Any trading center wishing to surveil its trading
  activities and recreate any violation scenario
  for regulatory authorities and customers.

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Improvements

• Additional streams and rule modules for other
  violations such as
• Wash sales
• Locked/Crossed Markets
• Front-running
• More advanced GUI.
• Inclusion of a monitoring mechanism to observe
  system activity.

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References

• Wikipedia lthttp//en.wikipedia.orggt
• SEC Website lthttp//www.sec.govgt
• Investopedia lthttp//www.investopedia.orggt
• SEC Reg NMS Document 34-50870
• Wallstreet Technology Website
  lthttp//wallstreetandtech.comgt
• MiFID Podcast ltwww.mifidpodcast.comgt