What Are Alternative Trading Systems?

Alternative Trading Systems (ATSs) are electronic platforms that facilitate the buying and selling of securities outside of traditional stock exchanges. While meeting the definition of an "exchange" under federal securities laws, these systems are not required to register as national securities exchanges if they comply with specific exemption conditions outlined in Regulation ATS by the U.S. Securities and Exchange Commission (SEC).

Key Characteristics of ATSs

Several key characteristics define ATSs and differentiate them from traditional exchanges:

1. Regulatory Framework: ATSs must register as broker-dealers and file an initial operation report with the SEC on Form ATS before commencing operations. They are also required to file amendments to Form ATS for any changes to their operations and a cessation of operation report if they cease operations.
2. Exemption Conditions: To operate under the exemption provided by Exchange Act Rule 3a1-1(a), ATSs must comply with Rules 300-303 of Regulation ATS. This includes maintaining certain standards for order protection, disclosure, and other operational requirements.
3. Data Transparency: The Financial Industry Regulatory Authority (FINRA) provides quarterly statistics on ATS activity, including total shares, total trades, and average trade size per ATS. This data provides valuable insights into the volume and activity within these systems.

Recent Trends and Statistics

Recent years have witnessed significant growth and evolution in the ATS landscape:

1. Increased Activity: The Municipal Securities Rulemaking Board (MSRB) has observed a substantial increase in pre-trade quote volume and trades on ATS platforms since 2018. This surge in activity has led to measurable improvements in trade prices relative to best quotes for both customer buy and sell trades.
2. Customer Trading Growth: The number of customer trades executed on ATSs has grown dramatically, from a mere 2.9% of all customer trades in 2015 to a significant 12.4% in 2022. This growth is particularly notable in the municipal bond market, where ATSs have become increasingly crucial for institutional customers, including municipal bond Separately Managed Accounts (SMAs).
3. Inter-Dealer Trades: While ATSs have maintained a prominent role in inter-dealer trades, their share has remained relatively stable at approximately 55% of all inter-dealer trades since 2020. However, their transactions with institutional customers have experienced significant growth, particularly in the first half of 2022.

Future Developments

Looking ahead, the SEC is actively working to modernize the regulatory framework governing ATSs. The SEC plans to finalize changes to expand and modernize the rules on ATSs in early 2024. These updates aim to enhance the regulatory framework for these systems, ensuring they continue to operate efficiently and transparently while maintaining market integrity.

Conclusion

Alternative Trading Systems play a crucial role in the modern securities market by providing efficient and flexible platforms for buying and selling securities. Their growth and increasing importance are evident in recent trends and statistics, and ongoing regulatory efforts aim to support their continued evolution and contribution to a robust and dynamic marketplace.