Last month the Securities and Exchange Commission approved the International Securities Exchange’s new qualified contingent cross (QCC) order type after a 20-month fight between ISE and several of its competitors. The CBOE had circulated a petition objecting to the QCC orders, saying they could harm the U.S. options market. ISE launched the QCC orders on February 28. JLN Options editor Sarah Rudolph spoke with Gary Katz, Chief Executive Officer of the ISE, about how the QCC works and his opinion on the controversy.
Q: Would you explain how a qualified contingent cross works?
A: An ISE member firm that has a tied-to-stock options order (a “contingent trade” or “complex trade”), can now cross that order (put up both sides of the options trade on ISE’s market with guaranteed execution) as long as the options component is at least 1,000 contracts and the order is priced at or better than the National Best Bid or Offer (NBBO). This trade will take place instantly as long as it does not trade in front of resting customer orders. Market participants must identify this type of order as a QCC. The options component is executed on ISE and our surveillance team monitors these trades to ensure that the stock trade is also taking place.
Q: Why is there controversy around ISE’s QCC order type?
A: This is not a new order type. These trades have always taken place on exchange floors, but they’re very difficult to do in an electronic environment. The QCC order type allows ISE to execute these orders in the same way they have always been done on the floor. For the first time since September 2009, we can compete for these large crossing orders on a level playing field with floor-based exchanges.
The floor-based exchanges have argued that these large, complex transactions are not instantaneously crossed when they are taken to the floor. They say that the big difference on the floor is that the orders are announced to the crowd and there’s an opportunity for the trade to be broken up. They have said that there is a lot of competition for that order, which is important to the options market.
While it makes sense that a floor-based exchange would make this argument, it is simply not true today. The reality is that the institutional-sized complex orders taking place on the floor today are “clean crosses.” If you go to one floor that doesn’t allow the clean cross, you can just shop the order around until you find an exchange that will allow it.
This was not always the case. The floor I grew up on at the New York Stock Exchange and the other floors across the industry used to be very different places. Back then, there were crowds of participants in any physical space where options were traded. When you brought one of these order types to the floor there was active involvement and competition. But that was a long time ago. Today these floors are shadows of their former selves. While the floor-based exchanges would have you believe otherwise, the fact is that if you go down to a floor today you will see wide open spaces. If you’re going into a crowd with a cross today, it’s possible that no one will hear you. Even if you know there is a crowd on one particular trading floor, you can go to another floor where there is no crowd. Without active participants, large complex orders are being crossed cleanly today.
QCC allows ISE to execute these types of trades electronically, on a level playing field with the floor-based exchanges. It is natural that the trading floors pushed back because it is a competitive issue. Until now, they had that exclusive volume.
Q: What do you mean by a “clean cross”?
A: A “clean cross” means that a market participant can put up both sides of a trade without exposing the order to the market, and there is a guaranteed execution. However, when talking about QCC it is important to remember that the conditions I mentioned previously must be met.
Q: The SEC originally approved ISE’s QCC proposal in 2009, but the launch was delayed until last month because of strong opposition by the CBOE and NYSE Euronext. Why do you think the SEC ultimately allowed you to introduce this type of order?
A: Although it took many months for the procedural appeal process to be resolved at the SEC, we are grateful for the fair manner in which the Commission and staff evaluated our proposal. Part of their rationale for approval was based on the fact that Reg NMS recognizes that certain types of trades are very complex, involving multiple markets and different legs. The SEC has granted certain exceptions in order to allow these trades to take place.
I think it also goes back to a point I made earlier. These trades take place today on exchange floors, and we are pleased that the SEC reached the same conclusion in approving the order type.
Q. Is this internalization, as some of your competitors have argued?
A: QCC is not an internalization issue, it is a competitive issue. I think that term is used to try to scare people. Opponents have used buzzwords like “retail internalization,” “dark pools,” and “lack of exposure.” It’s none of those. QCC orders are being handled exactly the same way they are done on the floor, so I see no greater internalization than on the floor.
Q: Is this, as some have argued, taking the U.S. options market closer to the European market model?
A: This is nowhere near the European structure where any order of any size can be traded off market and taken to an exchange. I think this is part of the “kitchen sink” approach that opponents have taken. These are phrases thrown out to try to scare people.
Q: The U.S. options market would not be happy with a European market model.
A: Nor would I. The U.S. has a perfect blend of a transparent, on-exchange options market. I do not want to see dark pools for options. Market makers provide tight and competitive quotes in a transparent market where order flow interacts and participants can get the best price. I don’t believe QCC threatens that at all.
Another “kitchen sink” term that has been used is “slippery slope.” But it’s only a slippery slope if the regulator allows that to be the case, or if any other exchanges move to make it so. QCC was a competitive issue, and we are now allowed to compete for these large crossing orders on a level playing field with floor-based exchanges.