Part 3: Intermarket Sweep Orders
Rule 611 of Regulation NMS is called the Order Protection Rule, more commonly known as the “trade-through rule.” Its goal is to prevent orders on one exchange from being executed at prices that are inferior to those “protected” quotes at another exchange. This rule forces exchanges to either reject marketable orders or route them to the exchange displaying the best price. In conjunction with Rule 610, Rule 611 provides a key protection that prohibits exchanges from executing trades that can be filled at better prices at away markets, a crucial property for binding markets in a single, unified national best bid and offer.
In theory, this rule should help investors get the best price in the market, regardless of where an order initially is routed. In practice, however, high-frequency traders have undermined the ability of others to secure the best price by exploiting an increasingly fragmented market.
In 2005, when the Reg NMS framework was being developed, decimalization in the U.S. equity markets had already resulted in a thinning of size available at the top of book, a general reduction in available market depth, and the deployment of sophisticated broker routing technologies to trade across the fragmented U.S. equities marketplace. With the threat of impending trade-through regulation, institutional traders were understandably concerned that Rule 611 would interfere with a broker’s ability to serve an institutional investor when trading in parallel across execution venues as exchanges attempted to fulfill their trade-through requirements across a fragmented marketplace. The problem is that if the client needs to access liquidity across all markets instantaneously but is prevented from doing so, the market impact of the trade could lead to rapid withdrawal of liquidity by market makers and/or situations in which the broker is unnecessarily forced to chase liquidity with orders that are denied by exchanges in an effort to comply with Rule 611. In fact, the resulting race conditions between market centers creates technological pandemonium in the price feed that frequently interferes with access to instantaneous liquidity by institutional investors in a variety of conditions.