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
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
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.
PCX- Bid 49 | Ask 52 BSE- Bid 50 | Ask 51 NYSE- Bid 50 | Ask 52 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.”
Trade Through 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] BSE’s NBB for 91.12 was traded through by an inferior order at NYSE at 91.11.
Order Protection Rule cont’d… • 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.
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).
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”.
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 - Fixed Period] [Trade Time] NBBO Timeline Relevant Time Window
My Solution? Renegade Equity Surveillance Replay! Replay quotes/trades over a time period, recreate price range, and detect trade through scenarios.
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
Record Violation Read Trades Overview of the System Read Quotes Construct NBBO Stream Analyze Data View Results Data Source: Database Database Database Security Admin
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
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 Database Handler Streamer NBBOs Quotes NBBO Stream
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
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
View Results Read Quotes Construct NBBO Analyze Data View Results • Graphical User Interfaces: • Operation Console • Configuration windows • Violations Display
Demonstration • Scenario: • Equity: “VZ” - Verizon Wireless • Start Date/Time: Dec 21 2006 15:00 • End Date/Time: Dec 21 2006 15:30 • Exchange: “B” - BSE • Expected result: 1 violation
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
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.
<Streamer> <Analyzer> BSEQuo. <Rule> WashSales <Rule> TradeThrou.. <Rule> FrontRunn. NBBO AllPric.. 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.
References • Wikipedia <http://en.wikipedia.org> • SEC Website <http://www.sec.gov> • Investopedia <http://www.investopedia.org> • SEC Reg NMS Document 34-50870 • Wallstreet & Technology Website <http://wallstreetandtech.com> • MiFID Podcast <www.mifidpodcast.com>