Self-Regulatory Organizations; NYSE Arca, Inc.; Notice of Filing of Amendment No. 1, and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Add a New Discretionary Pegged Order

I. Introduction

On March 11, 2016, NYSE Arca, Inc. (“Exchange” or “NYSE Arca”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change to amend NYSE Arca Equities Rule 7.31P(h) to add a new Discretionary Pegged Order. The proposed rule change was published for comment in the Federal Register on March 30, 2016. The Commission received two comment letters on the proposed rule change and a response letter from the Exchange. On May 12, 2016, pursuant to Section 19(b)(2) of the Act, the Commission designated a longer period within which to approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to disapprove the proposed rule change. On June 23, 2016, the Exchange filed Amendment No. 1 to the proposed rule change. The Commission is publishing this notice to solicit comments on Amendment No. 1 from interested persons, and is approving the proposed rule change, as modified by Amendment No. 1, on an accelerated basis.

II. Description of the Proposed Rule Change

The Exchange proposes to amend NYSE Arca Equites Rule 7.31P(h) to add a new Discretionary Pegged Order for its Pillar trading platform. According to the Exchange, the proposed Discretionary Pegged Order is based on the Discretionary Peg Order (“D-Peg Order”) proposed by IEX in its Form 1 application seeking registration as a national securities exchange.

Proposed Rule 7.31P(h)(3) would provide that a Discretionary Pegged Order would be a Pegged Order to buy (sell) that upon entry to the NYSE Arca Marketplace would be assigned a working price equal to the lower (higher) of the midpoint of the PBBO (“Midpoint Price”) or the limit price of the order. Any untraded shares of such order would be assigned a working price equal to the lower (higher) of the PBB (PBO) or the order's limit price and would automatically be adjusted in response to changes to the PBB (PBO) for buy (sell) orders up (down) to the order's limit price. In order to trade with contra-side orders on the NYSE Arca Book, a Discretionary Pegged Order to buy (sell) would exercise the least amount of price discretion necessary from its working price to its discretionary price (defined as the lower (higher) of the Midpoint Price or the Discretionary Pegged Order's limit price), except during periods of quote instability, as defined in proposed Rule 7.31P(h)(3)(D).

Proposed Rule 7.31P(h)(3)(A) would provide that Discretionary Pegged Orders would not be displayed, must be designated Day, and would be eligible to be designated for the Core Trading Session only. Discretionary Pegged Orders that include a designation for the Early Trading Session or Late Trading Session would be rejected.

Proposed Rule 7.31P(h)(3)(B) would provide that when exercising discretion, Discretionary Pegged Orders would maintain their time priority at their working price as Priority 3—Non-Display Orders and would be prioritized behind Priority 3—Non-Display Orders with a working price equal to the discretionary price of a Discretionary Pegged Order at the time of execution. If multiple Discretionary Pegged Orders are exercising price discretion during the same book processing action, they would maintain their relative time priority at the discretionary price.

Proposed Rule 7.31P(h)(3)(C) would provide that a Discretionary Pegged Order would be eligible to exercise price discretion to its discretionary price, except during periods of quote instability. If the Corporation determines the PBB for a particular security to be an unstable quote, it would restrict buy Discretionary Pegged Orders in that security from exercising price discretion to trade against interest above the PBB. If the Corporation determines the PBO for a particular security to be an unstable quote, it would restrict sell Discretionary Pegged Orders in that security from exercising price discretion to trade against interest below the PBO.

Proposed Rule 7.31P(h)(3)(D) would set forth how the Exchange would determine the quote instability factor (i.e., the probability of an imminent change of the current PBB to a lower price or the current PBO to a higher price). When the quoting activity meets predefined criteria and the quote instability factor is greater than a defined threshold (“quote instability threshold”), the Corporation would treat the quote as not stable (“quote instability” or “crumbling quote”). When the Corporation determines either the PBB or the PBO is unstable, the determination would remain in effect at that price level for ten milliseconds. The Corporation would only treat one side of the PBBO as unstable in a particular security at any given time.

The Corporation would determine that there is quote instability or a crumbling quote when the following occur: The PBB and PBO are the same as the PBB and PBO one millisecond ago; and the PBBO spread is less than or equal to the thirty-day median PBBO spread during the Core Trading Session; and there are more protected quotations on the far side; and the quote instability factor is greater than the defined quote instability threshold.

The quote stability calculation used to determine the current quote instability factor would be defined by the following formula:

1/(1 + e ^ −(C0 + C1 * N + C2 * F + C3 * N−1 + C4 * F−1)).

The Exchange proposes to use the following quote stability coefficients: C0 = −2.39515; C1 = −0.76504; C2 = 0.07599; C3 = 0.38374; and C4 = 0.14466. The Exchange proposes to use the following quote stability variables: N = the number of protected quotations on the near side of the market; F = the number of protected quotations on the far side of the market; N−1 = the number of protected quotations on the near side of the market one millisecond ago; and F−1 = the number of protected quotations on the far side of the market one millisecond ago. The Exchange proposes to use a quote instability threshold of 0.32.

Pursuant to proposed Rule 7.31P(h)(3)(D)(i)(D)(3), the Exchange reserves the right to modify the quote stability coefficients or quote instability threshold at any time, subject to the filing of a proposed rule change with the Commission.

Proposed Rule 7.31P(h)(3)(E) would provide that if the PBBO is locked or crossed, both an arriving and a resting Discretionary Pegged Order would wait for a PBBO that is not locked or crossed before the working price is adjusted and the order becomes eligible to trade.

The Exchange anticipates that it will announce the implementation date of the proposed rule change by the fourth quarter of 2016.

III. Summary of Comments and Response to Comments

The Commission received two comment letters opposing the proposed rule change and a response letter and an amendment from the Exchange.

One commenter points out that, as noted by the Exchange, the proposed Discretionary Pegged Order is a copy of the D-Peg Order that the commenter created, which has been offered since November 2014 by the IEX Alternative Trading System. This commenter states its belief that the D-Peg Order is a useful order type that can protect investors, if implemented properly. However, this commenter questions the effectiveness of the proposed Discretionary Pegged Order, and states that it should not be approved unless the Exchange amends the proposal and provides additional justifications to show that the order type would work as purported. Specifically, this commenter states that the Exchange would not be in a position to deliver the benefits as claimed if it continues to offer co-location and microwave services to fast market participants because the Exchange would not be able to effectively update the order during a crumbling quote faster than the market participant trying to pick off the order. This commenter also questions whether the Exchange understands the use of the proposed order type and expresses concern that the implementation of order types that are not well thought-through can increase systemic risk and may have adverse impacts on investor protection. According to the commenter, the D-Peg formula was calculated based on the location of its systems in Weehawken, NJ, and its unique latency profile, and it makes little sense to apply the same formula to orders on the Exchange located in Mahwah, NJ. Finally, this commenter argues that the Exchange should adopt a different name for the proposed order type to avoid confusion and misrepresentation regarding the nature of the order type.

Another commenter also opposes the proposed rule change. According to this commenter, Commission approval of exchanges' use of predictive order types such as the proposed Discretionary Pegged Order would result in rapidly increasing order type complexity, which would reduce market resilience and make markets more opaque for all investors. The commenter states its belief that the utility of these order types is marginal and does not outweigh the additional complexity that these order types would impose on the market. This commenter also expresses concerns regarding how the Commission could or would effectively review and police additional predictive order types as they emerge and evolve, and whether the Commission would propose guidance or limitations on how predictive order types may operate. Finally, this commenter states that predictive order types encroach on the traditional role of broker-dealers by using inherent competitive advantages that exchanges have over broker-dealers.

In response to comments, the Exchange indicates that the proposed Discretionary Pegged Order is a competitive response to IEX's D-Peg Order. The Exchange states that the proposed calculation to determine whether a quote is unstable is a straightforward determination that does not require inbound order flow to be intentionally delayed to be effective. According to the Exchange, while an intentionally-delayed market may prevent arriving interest from interacting with pegged orders immediately, it does not believe that processing market data updates and inbound orders out of phase (as with IEX) or simultaneously (as proposed by the Exchange) would materially alter the effectiveness of the proposed functionality. The Exchange also states its belief that the benefits of the proposed functionality would be the same regardless of the relative speed. Moreover, according to the Exchange, the proposed Discretionary Pegged Order would be an optional order type, and if market participants do not believe that the quote instability formula appropriately predicts market movement, they do not have to use the order type. The Exchange states that, over time and based on client feedback, it would consider changes to the specific formula used to assess the quality of the market or would consider offering additional types of Discretionary Pegged Orders to serve the trading needs of different market participants, subject to filing separate proposed rule changes with the Commission. Finally, the Exchange states that it does not anticipate that the proposed order type would have any disruptive effects on the overall market.

IV. Commission Findings

After careful review, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange. In particular, the Commission finds that the proposed rule change, as modified by Amendment No. 1, is consistent with Section 6(b)(5) of the Act, which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest.

As noted above, the proposed Discretionary Pegged Order is based on IEX's D-Peg Order, although there are some differences between the two orders. First, unlike IEX's D-Peg Order, the proposed Discretionary Pegged Order must have a limit price. The Commission notes that this is not a novel aspect for this type of order because IEX's D-Peg Order is also permitted to have a limit price, although it is not required to have one. Second, unlike IEX's D-Peg Order, the proposed Discretionary Pegged Order must have a Day time-in-force. The Commission similarly notes that this is not a novel aspect for this type of order because IEX's D-Peg Order is also permitted to have the Day time-in-force, although it is permitted to have certain other times-in-force as well. Third, if the PBBO is locked or crossed, an arriving or resting Discretionary Pegged Order would wait for a PBBO that is not locked or crossed before the working price is adjusted and the order becomes eligible to trade, whereas IEX's D-Peg Order can be priced and traded if the market is locked or crossed. The Commission notes that the proposed treatment of Discretionary Pegged Orders when the market is locked or crossed is consistent with Exchange Rule 7.31P(h)(1)(B), which governs the treatment of other non-displayed pegged orders on the Exchange (i.e., Market Pegged Orders) when the market is locked or crossed.

The Commission notes that, according to the Exchange, the proposed Discretionary Pegged Order would assist ETP Holders in obtaining best execution for their customers by limiting executions at the Midpoint Price when the PBBO is not stable, and by reducing the potential to execute at a stale price. Moreover, the Commission notes that, in response to the comments, the Exchange acknowledges that an intentionally-delayed market may prevent arriving interest from interacting with pegged orders immediately, but states its belief that the proposed Discretionary Pegged Order would be effective, notwithstanding the differences in speed between the Exchange and IEX.

With respect to questions regarding whether the proposed Discretionary Pegged Order would perform a function that is typically performed by broker-dealers, and whether approval of the proposed Discretionary Pegged Order would be inconsistent with the Commission's prior disapproval of Nasdaq's “benchmark orders,” the Commission notes that, as with IEX's rules governing the D-Peg Order, proposed Rule 7.31P(h)(3) would delineate the specific conditions under which a Discretionary Pegged Order would or would not be eligible to execute up (down) to the Midpoint Price by setting forth the formula that the Exchange would use to determine quote stability. Also, as with IEX's D-Peg Order, the Exchange would encode in its rule the totality of the discretionary feature of the proposed Discretionary Pegged Order. As the Exchange notes in the proposal, the manner by which it would monitor the quality of the quotes would be objective and transparent, as set forth in the proposed rule. As with IEX's D-Peg Order, the Commission does not believe that the hardcoded conditionality of the proposed order type would provide the Exchange with actual discretion or the ability to exercise individualized judgment when executing an order. The Commission also notes that the Exchange would be required to submit a proposed rule change pursuant to Section 19(b) of the Act prior to implementing any changes to the proposed order. Moreover, as with IEX's D-Peg Order, the Commission believes that the proposed Discretionary Pegged Order is distinguishable from Nasdaq's benchmark orders and does not implicate the same issues.

With respect to a commenter's concern that approval of the proposed Discretionary Pegged Order would lead to the proliferation of complex predictive order types, the Commission notes that new exchange proposed order types are subject to the rule filing process of Section 19(b) of the Act and Rule 19b-4 under the Act, and the standards in Section 6(b) of the Act, among other provisions.

With respect to a commenter's request that the Exchange use a different name for the proposed order in order to avoid confusion and misrepresentation regarding the nature of the order, the Commission notes that the functionality of the proposed Discretionary Pegged Order is specifically delineated in proposed Rule 7.31P(h)(3). Moreover, the Commission notes that, currently, order types on different exchanges with nearly identical names may function differently. As a result, the Commission does not believe the Exchange's use of the name “Discretionary Pegged Order” raises regulatory concerns.

Finally, the Commission notes that existing exchanges offer both discretion and pegging functionalities, including the combination of both of those functionalities in a single order type. As with IEX's D-Peg Order, the proposed discretion functionality would be turned “on” or “off” depending on the Exchange's quote stability determination. Because the Exchange has encoded in its rule the totality of the discretionary feature of the proposed Discretionary Pegged Order, the Commission believes the proposed order type is a close variant of the discretion and pegging functionality that currently exist on other exchanges.

Based on the foregoing and the Exchange's representations, the Commission believes that the proposed rule change, as modified by Amendment No. 1, is consistent with the Act.

V. Solicitation of Comments on Amendment No. 1

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether Amendment No. 1 to the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form ( http://www.sec.gov/rules/sro.shtml ); or
• Send an email to rule-comments@sec.gov. Please include File Number SR-NYSEArca-2016-44 on the subject line.

Paper Comments

• Send paper comments in triplicate to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-NYSEArca-2016-44. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/sro.shtml ). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. Copies of the filing also will be available for inspection and copying at the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NYSEArca-2016-44 and should be submitted on or before July 22, 2016.

VI. Accelerated Approval of the Proposed Rule Change, as Modified by Amendment No. 1

The Commission finds good cause to approve the proposed rule change, as modified by Amendment No. 1, prior to the 30th day after the date of publication of notice of Amendment No. 1 in the Federal Register. In Amendment No. 1, the Exchange added subsection (E) to proposed Rule 7.31P(h)(3), which would provide that if the PBBO is locked or crossed, both an arriving and resting Discretionary Pegged Order would wait for a PBBO that is not locked or crossed before the working price is adjusted and the order becomes eligible to trade. As noted above, this aspect of the proposed Discretionary Pegged Order is consistent with Exchange Rule 7.31P(h)(1)(B), which governs the treatment of other non-displayed pegged orders on the Exchange (i.e., Market Pegged Orders) when the market is locked or crossed. In Amendment No. 1, the Exchange also provided additional responses to the comment letters and provided more information regarding the implementation date for the proposed rule change. These two changes do not alter the substance of the proposed rule change. Accordingly, the Commission finds good cause, pursuant to Section 19(b)(2) of the Act, to approve the proposed rule change, as modified by Amendment No. 1, on an accelerated basis.

VII. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-NYSEArca-2016-44), as modified by Amendment No. 1, be, and it hereby is, approved on an accelerated basis.