David Howson, who became global president of Cboe in May, likens market infrastructure to a motorway. “It’s like joining a queue at a toll booth,” says the head of the world’s largest equity options exchange, which has a market capitalization of $12.3 billion. “You’ve got some clerks that are faster at taking the money and doing things, and others that are slower.

“It’s about choosing the queue that is going to burn quickest. It’s not always the shortest queue—sometimes it can be the longest.”

It’s a fitting analogy for someone who has spent much of his career on the road designing and running stock exchanges—especially as US regulators look to pull some market participants on to the hard shoulder.

The Securities and Exchange Commission (SEC) is preparing an overhaul of the US cash equities market. The aim is to improve competition as equities are increasingly traded off-exchange and routed through market-makers such as Citadel Securities and Virtu.

Cboe operates lit venues—such as the exchanges set up by one of its previous iterations, BATS—as well as a dark block trading pool called BIDS that it acquired last year. BIDS is an alternative trading system (ATS), a set-up that allows for more lightly regulated trading of equities outside the major exchanges.

In a speech in June, SEC chair Gary Gensler noted that the proportion of the volume being traded off-exchange had grown from a quarter in 2009 to a peak of 47% during the meme stock event of early 2021, when hedge funds were humbled by an army of redditors. There were 55 equity ATSs in operation in the US as of September 22, according to the country’s Financial Industry Regulatory Authority—up from 33 in Q3 2021 according to the Securities Industry and Financial Markets Association. This compares with just 16 registered national exchanges.

Given these shifts, Howson believes ATSs should face the same transparency regulations as lit exchanges. Under the current system, for instance, it is easier for ATSs to change their fees and order-handling systems than it is for lit exchanges such as BATS, Nasdaq and the NYSE.

“The regulatory regime for ATSs is much lighter weight than with respect to exchanges,” he says. “Leveling of the playing field there makes sense.”

Go with the flow

Other areas Gensler has in his sights include payment for order flow (PFOF) and exchange rebates.

PFOF is when wholesalers pay retail brokers for their flow. The practice has made commission-free trading viable for retail brokers.

In its report on the meme stock event, the SEC voiced concerns that PFOF had incentivised brokers such as Robinhood to irresponsibly increase their retail client base, though the regulator has reportedly dropped plans to clamp down on the practice.

Action on exchange rebates, however, is still on the table. These payments enable exchanges to compete with off-exchange competition, thereby incentivising investors to send orders to exchanges. Traders on Cboe’s EDGX equities exchange are given a $0.00160 rebate for trading any security valued at $1 or above. In his speech, Gensler said exchange rebates could create conflicts of interest for brokers when they are choosing where to route their retail orders.

It was not the first time the SEC had come after the rebates, which were introduced in the late 1990s by upstart electronic communications networks in an effort to compete with the Nasdaq and NYSE. ICE, Nasdaq and Cboe sued the regulator to prevent it implementing a pilot scheme that would have scrapped rebates. In June 2020, the US Court of Appeals for the District of Columbia Circuit ruled in favour of the exchanges, noting that the SEC had failed to justify the economic case for even running a pilot that would have restricted order flow incentives.

Howson though warns against conflating the fuss over PFOF with the argument over exchange rebates: “Rebates and PFOF are two different things, not to be conflated.” He points out that rebates are available to all market participants, many of which “don’t handle customer order flow. The notion of a conflict related to that type of flow doesn’t exist”. He expects the SEC to provide greater clarity about its plans over the coming weeks.

Although he admits that “no market structure is perfect”, Howson thinks the US equity market, based on the simple idea of best execution, has a strong foundation. However, he also believes it is time for the US authorities to update the rules governing securities trading venues.

“The US equity market is the most vibrant, deep equity market in the world, so [clearly] it has done something right,” he says. “Certainly, looking over the years, looking at market structure when going through Mifid I and Mifid II, we would envy the single model of the US.”

Tales from the crypto

Whether digital assets should be regulated as securities or commodities is another debate that continues to rage in Washington. FTX US, the onshore subsidiary of Bahamas-based crypto derivatives exchange FTX, has filed an application with the US authorities to allow it to give retail investors direct access to a clearing house. Such a model would bypass the brokers that have traditionally acted as gatekeepers to the derivatives market.

In October 2021, Cboe agreed to buy ErisX, which runs a cryptocurrency exchange and clearinghouse. The sale completed in May, though in July Cboe announced it had taken a $460 million writedown on the deal.

Despite this, Howson says “the value proposition that drove us to ErisX in the first place remains the same and the opportunity remains the same. The direction of travel, and the tailwinds, from the soundings we are hearing from the regulators really gives us conviction that the model we decided upon is the right model. That model is one of an exchange, clearing house, intermediaries, and a prudent listings policy.” 

It’s good to have options

Cboe is best known for its toolkit of derivatives that allow investors to hedge or bet on the S&P500 index.

Howson says 2022 has been a year of “tremendous growth” for SPX options. The average daily volume has more than doubled from a little over 1 million trades in October 2021 to more than 2 million last month. Cboe hit a new single-day volume record on September 23, when 3.8 million contracts were traded—beating the previous record of 3.6 million on February 28, 2020. Trading hit a monthly all-time high in September, when a record 59.2 million contracts were traded—15 percent more than during the previous record month in August.

Retail investors’ participation in the options market has exploded since the start of the pandemic. In January 2020, just under half of SPX options users were retail traders; in October 2022, the figure was 83%. Institutional usage remained steady over the same period, but retail involvement in the market leapt 269%, resulting in an average daily volume of 1.8 million trades last month.

The SPX complex is reaping the benefits of Cboe’s strategy of giving traders—pun intended—more options. “The broader theme, and you’ll see us do this everywhere, is extending access,” says Howson.

Cboe was ahead of the retail zeitgeist back in 2017 when it introduced mini-contracts, such as the one tenth sized instrument. This year, it has brought in weekly SPX expiries for Tuesdays and Thursdays—expiries having only previously been available on Mondays, Wednesdays and Fridays. “You now have a contract expiring every day of the week,” says Howson. “What that’s provided the industry—and, in particular, users of retail brokerage platforms—is a finer grained control over managing portfolios and managing risk, and trading opportunities throughout the day. We’ve seen incremental growth as a result of filling in those pockets on Tuesday and Thursday that were missing previously.”

As well as increasing the variety of options expiries available and the size of the contracts traded, Cboe has this month expanded the trading hours of its Chicago-based options exchange to 24 hours a day, five days a week. “We’ve seen growth in unique retail accounts trading during those hours as well,” says Howson.

In 2021, Cboe acquired Chi X Asia Pacific from private equity firm JC Flowers, which gave its customers access to the Japanese and Australian markets. It is now moving both exchanges on to the same technology stack as its US and European venues.

“We are bringing uniform technology, uniform access, uniformity of licensing agreements for the data, and uniformity of protocols,” says Howson. “And then you get the opportunity to bring trading protocols from one region to another where they suit the local environment.” As an example, he points to the periodic auctions, pioneered by BATS in Europe, which are now being used in the US to provide “low impact execution”.

Share power

In 2007, Europe's national exchanges had a monopoly on all trades. Then along came Mifid I. This created multilateral trading facilities (MTFs), which could compete with national exchanges to trade the same securities. Mifid I and Mifid II helped to force down prices, and created a new world of block trading, dark pools and lit venues. Cboe Europe Equities, a pan-European exchange based in the UK and the Netherlands, is the descendant of the early MTFs such as BATS Europe and Chi X Europe.

In July, Cboe Europe Equities became the largest stock exchange in Europe by market share, overtaking the likes of Euronext, Deutsche Börse and the London Stock Exchange in terms of cash equities volumes. According to the exchange’s own data, it had a 24.9% share of the European equities market in September, up from 17.2% two years previously.

Cboe’s strategy has long been to plug the huge amount of data generated by its equities trading business into index products. The Cboe Volatility Index (VIX), launched by the company back in 1993, was an early example of this. Howson attributes the expansion of Cboe Europe Equities to the way that the company has been able to package and analyse the torrent of information created through its trading activities.

He says that data analysis conducted in 2021, and updated in 2022, found that orders queued on the pan-European exchange are filled at a faster rate than at its competitors. This increases execution certainty—a key consideration for participants when choosing where to post orders. Howson says the certainty Cboe offers is typically the same as or better than that of its rivals—and much better than the exchange’s own historical market share would suggest.

Cboe’s ability to move the queue along more quickly was crucial in convincing European traders to post an increasing amount of passive orders through its lit equities venues. “That increase in market share is purely driven by our data,” says Howson. “You are going to be no worse off and potentially better by posting more orders.”

And as any motorway user knows, it’s best not to spend too long in the slow lane.