Bloomberg, industry bodies push back on Cboe’s proposed OEMS rule change

On Thursday, the comment period closed for a controversial proposal by US options exchange Cboe to remove exchange-affiliated order execution management systems from the Securities and Exchange Commission’s definition of an exchange facility. If Rule 3.66 is adopted, it would allow Cboe to raise fees on and make changes to its Silexx OEMS without seeking SEC approval.

Cboe says the proposal will help it compete with other non-exchange and unregulated OEMS providers. But in comment letters from Bloomberg, the Securities Industry and Financial Markets Association (Sifma), and others, industry peers have bristled at the exchange’s attempt to narrow the regulatory scope of a facility. The legal specification, created by the Exchange Act of 1934, allows the SEC to regulate parts of the exchange that fall outside of trading, such as the cost and dissemination of market data, co-location arrangements, connectivity access, and more.

The whole exchange model is somewhat broken here

Source at an industry body

Among the complaints raised by commenters is that Rule 3.66, if approved, could set a precedent wherein exchanges could file to exempt certain functions or offerings from the definition of a facility of an exchange.

While exchanges today are billion-dollar publicly traded companies, many of the regulations that govern them are left over from rules designed to govern the private, not-for-profit members groups they were prior to the early 2000s. “The whole exchange model is somewhat broken here,” says a source at an industry body.

As traditional exchanges’ business has stalled, they have moved into software, market data, co-location and other revenue streams. At the same time, Bloomberg and others have noted that exchanges and legislators have sought to limit the definition of “facility”—including with two bills proposed to Congress in 2017 and 2023—which many of these new software and data products fall under.

An OEMS is software that market participants and brokers can use to place and manage their orders. Though an OEMS connects orders to exchanges, Cboe argues that because separately purchased exchange ports are the mechanisms that ultimately connect an order to an exchange, an OEMS is separate from an exchange. It also says that these OEMSs are optional; without one, someone can still send orders to Cboe’s markets.

Andy Mahoney, managing director of competing OEMS provider FlexTrade, says that the proposal, if effective, could provide vindication for OEMS providers that believe they are separate entities from trading venues and exchanges. Mahoney, who is based in the UK, notes that this has been the topic of a long-running debate throughout Europe and the UK.

“I see it as an acknowledgement that an OEMS can exist without an exchange, and an exchange can exist without an OEMS,” he says. “It is a piece of technology. It’s a piece of software, not the venue itself, not the matching engine itself. It’s positive news for those looking for clarification on what is an OEMS vs. what is a venue.”

I see it as an acknowledgement that an OEMS can exist without an exchange, and an exchange can exist without an OEMS

Andy Mahoney, FlexTrade

Last year, the European Securities and Markets Authority (Esma) said that any platform bringing together multiple buyers and sellers that might interact with one another could be defined as a “multilateral system,” though it acknowledged that there was no consistent view about what would constitute such a system. 

Its view was echoed by the UK’s Financial Conduct Authority (FCA), which wrote that a system’s features, rather than the language it used to describe itself, would determine whether it should be regulated.

Despite the guidance, the question was largely left unanswered, leaving implicated tech providers to conduct their own analyses and await enforcement actions from the various national competent authorities.

Not on their watch

Opponents of the proposal note that a rewrite of the exchange facility definition could severely limit the SEC’s ability to regulate the growing gambit of exchange-provided services, including market data and its ever-rising costs. They also object to Cboe’s assertion that an OEMS is separate from an exchange, noting that previous decisions around smart order routers ruled that similar functions to an OEMS may be considered part of an exchange’s facility.

For example, comment letters from Bloomberg and low-latency network provider McKay Brothers point to the fact that Cboe is already waiving Cboe port fees for its Cboe Silexx OEMS to offset the advantage of non-exchange OEMS providers.

“Will all exchanges be permitted to offer themselves unilateral exemptive relief from Congressional statutes and Commission rules for other products or services—like market data or order types—that are facilities of the exchange?” Greg Babyak, head of government and regulatory affairs at Bloomberg, wrote in one of the company’s comment letters.

As Cboe has noted, Bloomberg also operates its Trade Order Management Solutions product suite, TOMS, and execution management services, which are not subject to the same regulatory approvals on price changes as Cboe’s Silexx. The exchange also notes that the OEMS platform provided to trading permit holders would be a facility of the exchange, but that the reclassification applies specifically to the OEMS platform provided independently to brokers.

Adam Inzirillo, global head of data and access solutions at Cboe, tells WatersTechnology that the exchange lacks flexibility afforded to non-exchange OEMS providers, which makes offering a competitive platform difficult. Differentiated pricing allows providers to adjust costs and fees for factors such as usage and use-case in a client-tailored model, whereas Cboe and other exchanges must charge clients the same amounts universally.

After Cboe acquired Silexx in 2017, it created two versions of the platform, Silexx Flex and Cboe Silexx. According to its most recent fee schedule, the exchange charges Silexx users between $200 and $600 per month per login ID, based on various functionality plans, such as basic, pro, sell side, buy-side manager, and more.

“To the extent that the proposed changes make Cboe Options a more attractive marketplace for market participants at other exchanges, such market participants are welcome to become Cboe Options market participants,” Cboe wrote in its rebuttal to dissenting public comments from Bloomberg and the Healthy Markets Association.

To those opposing the proposal, these examples of differentiated pricing foreshadow what could happen if exchanges are allowed to carve certain products out of the definition of a facility. As exchanges have seen dips in their listing businesses, and as less of their profits are generated from trading volumes, they have turned to alternative revenue streams. The objections to Cboe’s proposal reflect a larger industry concern that the exchange industry’s expansion into other business lines, such as technology products and services, could disadvantage non-exchange providers and intervene with US market structure.

The SEC has given until July 11 for rebuttals to the existing comment letters. From then, the industry will watch closely to see how the Commission answers the question of whether an OEMS should be regarded as an exchange facility, and if not, what affect that could have on the exchange industry and the US market structure.