Alternative Trading System (ATS)

An Alternative Trading System (ATS) is a non-exchange trading venue that matches buyers and sellers to find counterparties for transactions. These systems facilitate trading in a variety of assets, including stocks, bonds, and derivatives, but they do so outside of traditional public stock exchanges. ATSs often operate under various regulations as well as certain restrictions, yet they offer benefits like reduced costs and faster trade execution. This document provides a comprehensive overview of ATS, its types, functioning, advantages, regulations, and notable examples.

Types of ATS

Electronic Communication Networks (ECNs)

ECNs are computerized systems that automatically match buy and sell orders for securities in the market. These networks allow traders to bypass brokers and interact directly with the market, thus reducing transaction costs. Notable examples include:

• NASDAQ

  NASDAQ operates multiple ECNs that facilitate trading in securities.

Dark Pools

Dark pools are private financial forums or exchanges for trading securities. Unlike public exchanges, the orders placed in dark pools are not visible to the public, hence the term “dark.” These systems are typically used by larger institutional investors to execute large trades without affecting the market price. Notable examples include:

• Liquidnet

  Liquidnet is a global institutional trading network, offering services in dark pool trading.

Crossing Networks

Crossing networks are a type of ATS that matches buy and sell orders electronically without routing the order to a public exchange. These networks often execute orders at predetermined times and prices. Notable examples include:

• ITG POSIT

  ITG POSIT is one such crossing network that provides anonymous, automated trading solutions.

How ATS Works

An ATS functions as an intermediary between a buyer and a seller, matching orders without the need to go through traditional exchanges. Below are the basic steps involved:

1. Order Placement: Orders are placed by investors through their brokers or directly if they have access.
2. Order Matching: The ATS’s system matches these orders based on their pricing and volume.
3. Trade Execution: Once a match is found, the trade is executed electronically.
4. Settlement: The trade is then settled, meaning the securities are transferred from the seller to the buyer and the cash is transferred in the opposite direction.

Order Types

Different types of orders can be placed in an ATS. These include:

• Market Orders: Orders to buy or sell immediately at the current market price.
• Limit Orders: Orders to buy or sell at a specific price or better.
• Stop Orders: Orders that become market orders once a specified price is reached.

Technology Stack

The technology stack of an ATS generally includes:

• Matching Engine: The core component responsible for matching buy and sell orders.
• Risk Management System: Ensures that trades comply with regulatory standards and risk profiles.
• Network Infrastructure: High-speed, low-latency networks to facilitate rapid trade execution.
• Security Measures: Cybersecurity protocols to protect the integrity of the trading system.

Advantages of ATS

Lower Costs

ATS often provides lower transaction fees compared to traditional exchanges. This cost efficiency is primarily due to reduced intermediaries and lower overhead costs.

Anonymity

Dark pools and some other types of ATS offer anonymity, which can be particularly beneficial for large institutional trades. This anonymity can reduce market impact and information leakage.

Flexibility

ATS allows for various order types and execution strategies, offering more flexibility to traders. This is especially useful for algorithmic trading where specific conditions need to be met.

Speed

With advanced technological infrastructure, ATS provides faster trade executions. This speed is crucial for high-frequency trading (HFT) and other strategy-based trading.

Regulatory Framework

United States

In the U.S., ATSs are regulated by the Securities and Exchange Commission (SEC) under Regulation ATS. They are usually required to register as broker-dealers and comply with specific standards related to transparency, fraud prevention, and trading practices.

• Finra

  Financial Industry Regulatory Authority (FINRA) oversees the quality and fairness of ATS operations in the U.S.

Europe

In Europe, ATSs are governed under the Markets in Financial Instruments Directive (MiFID II), which sets out rules to increase transparency and protect investors.

• ESMA

  European Securities and Markets Authority (ESMA) regulates financial markets in the European Union, including ATS.

Asia

Different Asian countries have their own regulatory bodies overseeing ATS operations. For example, Japan has the Financial Services Agency (FSA), while Hong Kong has the Securities and Futures Commission (SFC).

• FSA Japan

  Financial Services Agency (FSA) is Japan’s regulatory authority overseeing ATS.

Notable Examples

Instinet

Instinet is one of the pioneers in electronic trading and operates one of the oldest and most established ATS. It offers a suite of services including agency execution and trading technologies.

BATS Global Markets

BATS Global Markets operates as both an exchange and an ATS, providing multiple venues for trading equities and options.

Chi-X

Chi-X operates in multiple countries and offers a range of trading solutions. It is known for its technology-driven approach to improve market efficiency.

Conclusion

Alternative Trading Systems (ATS) represent a vital component of today’s financial markets. They offer numerous advantages in terms of cost, speed, and flexibility while posing unique regulatory challenges. As technology continues to evolve, the role and influence of ATS in the financial ecosystem are likely to expand further.