ISE Topaz Venue Would Increase American Options Exchanges to 12

International Securities Exchange Holdings Inc. plans to start an options market that will become the 12th U.S. exchange for equity derivatives.

Topaz Exchange will be owned by ISE, according to a regulatory filing published on March 1. Gary Katz, president and chief executive officer of the New York-based International Securities Exchange, said last year that the company planned to start a second market to compete with rivals CBOE Holdings Inc., Nasdaq OMX Group Inc. and NYSE Euronext.

“Exchanges are looking for anything to make money or make new waves,” Ben Schwartz, Chicago-based chief market strategist at broker New York-based Lightspeed Financial Inc., said by phone. “I’d think exchanges would look to monetize products they have, rather than expand,”

Market operators, most of which have become for-profit companies since 2000, use multiple venues with different methods of trading and sets of fees to attract orders from customers and compete with rivals. Two American options exchanges began last year even as volume fell 12 percent to 4 billion contracts, compared with a record 4.56 billion that changed hands in 2011, according to Chicago-based OCC, which clears and settles all equity derivatives trades.

ISE, which became the first all-electronic U.S. options exchange in May 2000 and is now owned by Frankfurt-based Deutsche Boerse AG, is the last major options exchange operator to run just one venue. Nasdaq OMX has three and CBOE and NYSE Euronext have two each. A unit of Deutsche Boerse bought New York-based ISE for $2.8 billion in 2007, according to data compiled by Bloomberg.

Options Volume

The ISE exchange accounted for 16 percent of U.S. options volume last month, OCC data show. The Chicago Board Options Exchange was the largest with 23.4 percent, followed by Nasdaq OMX PHLX with 19 percent.

ISE wanted to launch a venue that combined trading rules and fees in novel ways and wasn’t simply “another maker-taker or another pro-rata model,” Katz said in an interview in March 2012, referring to different rules for matching orders on options exchange. The proposal published by the SEC is similar to ISE’s existing structure. The fee schedule wasn’t included.

“We had hoped to come out of the box with something different,” Boris Ilyevsky, managing director of ISE Options Exchange, said by phone. “The initial market structure will look almost identical to ISE. We will definitely have a different fee structure and once we get it launched will be able to make additional changes to differentiate the offering.”

Trading Percentage

ISE doesn’t have a target percentage of trading it expects Topaz to gain this year, Ilyevsky said. The aim is to attract “incremental business” by offering an alternative in a way that doesn’t cannibalize the ISE’s volume, he said.

“There’s always a debate about the optimal number of exchanges in a particular marketplace,” Andy Nybo, a principal and head of derivatives at New York-based research firm Tabb Group LLC, said in a phone interview. “Is it two or five or 20? As long as a new exchange brings functionality and the ability to execute against liquidity in a new environment, it provides value to the marketplace.”

Industry participants already connected to ISE will be able to link easily to Topaz, Ilyevsky said. The trading platform, protocols for sending orders to the exchange and data center that houses the computer engines will be the same, he said.

Federal Register

The public can comment on the Topaz application to become an exchange for 45 days after it’s published in the Federal Register, according to the SEC. The agency must approve the application before the exchange can start trading.

Topaz will operate with at least $5 million from ISE and will initially rely on the same management as its parent company, the filing said. Its CEO and president will be Katz, while Thomas Ascher will be chief strategy officer. Daniel Friel will be chief information officer, Ilyevsky managing director, and Michael Simon chief regulatory officer. It will also have a 15-person board of directors, according to the filing.

ISE owns 31.54 percent of Direct Edge Holdings LLC, the operator of two U.S. stock markets. Topaz has no plans to start an equities exchange, according to the filing.

Topaz will include market makers and brokers among its members. Incoming orders will trade first against what the exchange calls priority customers. If the requests aren’t completely filled, they will trade against orders from professionals and quotes from market makers on a pro-rata basis that depends on the number of contracts those firms made available. The exchange initially won’t allow complex or multi-leg orders.

Topaz said it may offer an auction called a price-improvement mechanism to enable users to get prices better than the best nationally available bid and offer prices. It may also provide systems for a minimum of 50 contracts that allow firms to cross or trade larger orders, according to the filing. A so-called solicited-order mechanism would also allow firms to get executions for at least 500 contracts at a time.

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