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Bats Gets SEC Approval to Create Second U.S. Exchange

Bats Global Markets said it received Securities and Exchange Commission approval to start its second U.S. stock exchange as the company seeks to expand its share of equities trading.

Bats plans to open the platform, the 12th U.S. stock exchange, in October, according to a statement. Bats Y-Exchange, or BYX, may help the company better compete with NYSE Euronext, Nasdaq OMX Group Inc. and Direct Edge Holdings LLC, all of which operate at least two equity markets in the U.S.

Stock markets are fighting for business by introducing multiple venues, letting them experiment with pricing systems and techniques for matching orders to lure more traders. Exchange operators with more than one platform can attract different kinds of brokers and asset managers through rebates and fees, which have provided incentives to help keep U.S. markets liquid since stocks began trading in penny increments last decade.

“There will be fewer exchange companies with more medallions,” or trading licenses, said Larry Tabb, founder and chief executive officer of New York-based research firm Tabb Group LLC. Exchange companies want to use the same technology and data centers to operate multiple venues at a lower overall cost and employ those platforms to “cater to different types of traders,” he said.

Pricing Plan

Bats, based in Kansas City, Missouri, began trading stocks in 2006 and accounts for 11 percent of U.S. equity volume, the company said. It runs a U.S. options exchange and Bats Europe, a London-based trading venue. That market transacts more than 5 percent of European equities, Bats said in its statement.

The company hasn’t announced its pricing plan for BYX. The current Bats exchange pays firms that send bids and offers to the venue 24 cents for every 100 shares bought or sold. Investors who trade against those bids and offers are charged 25 cents, giving the exchange a 1-cent profit. The system is similar to fees at Nasdaq Stock Market and NYSE Arca.

Equity exchanges instituted fees and rebates in the last decade to attract brokerages whose traditional way of making money, capturing the spread between bid and ask prices, was squeezed as increments narrowed to pennies. The model, maker-taker pricing, usually rewards brokers and investors who put requests to buy and sell shares in an exchange’s book and charges those who execute against them.

Liquidity Providers

When multiple exchanges are quoting the best prices to buy and sell stocks, fees are a key consideration compelling brokers to send orders to a particular market. Other factors include how quickly the order is likely to be filled and how much liquidity is available at the best price on that venue.

Nasdaq OMX, based in New York, and Direct Edge Holdings LLC of Jersey City, New Jersey, also run venues aimed at discount brokers, whose customers are often individual investors, and firms handling orders from mutual funds and asset managers. Some of those brokers don’t want to pay higher fees to trade and prefer executing on venues with lower charges or rebates.

Instead of paying liquidity providers, platforms such as Direct Edge’s EDGA Exchange and Nasdaq OMX BX pay brokerages who execute against bids and offers already on their books. Market makers are willing to provide those bids and offers because they consider orders from those firms less likely to be part of predatory trading strategies. The two exchanges have also been favored by firms trading lower-priced stocks where a 1-cent spread is a larger percentage of the share price.

BYX Sandbox

“BYX gives us a sandbox to try new things on a stock-by-stock basis,” Chris Isaacson, chief operating officer of Bats, said in a February interview. “The percentage of trading in low-priced stocks on lower-priced venues is disproportionately higher.” He said at the time that BYX pricing was likely to appeal to firms that don’t want to pay 25 cents to “take liquidity,” particularly for less-expensive stocks.

Bats is owned by a consortium including Bank of America Corp., Citigroup Inc., Credit Suisse Group AG, Deutsche Bank AG, Getco LLC, JPMorgan Chase & Co., the estate of Lehman Brothers Holdings Inc., Lime Brokerage LLC, Morgan Stanley, Tradebot Systems Inc. and Wedbush Morgan Securities.

The SEC isn’t likely to halt the creation of new venues by existing exchange operators competing with one another, Tabb said. While the SEC may prefer fewer liquidity pools in the U.S., “we haven’t seen them move in that direction yet and that would be a substantial change for the SEC,” he said.

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