Alternative Trading System - Explained
What is an Alternative Trading System?
Written by Jason Gordon
Updated at September 21st, 2021
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Table of Contents
What is an Alternative Trading System?How Does an Alternative Trading System Work?Key Takeaways Regulation ATS ExplainedAcademics Research on Alternative Trading System (ATS)What is an Alternative Trading System?
An alternative trading system (ATS) is a non-exchange trading platform that is approved by the Securities and Exchange Commission (SEC). Buy and sell orders are matched on this trading platform to find counterparties ready to engage in trade. Investors or traders can subscribe to ATS so as to get their orders matched. Alternative trading systems are common in the US and Canada for regulatory purposes, they are considered as broker-dealers and not exchanges.
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How Does an Alternative Trading System Work?
Alternative Trading Systems (ATSs) are a popular non-exchange avenue for trading. They are electronic trading systems that are approved by the SEC to execute buy and sell orders. One of the major attributes of ATS is its high liquidity amongst other trading platforms and exchanges ATSs are required to undergo a registration process, these platforms focus on matching but and sell orders but do not function as actual exchanges, instead, they are registered as broker-dealers. There are some differences between ATS and national exchanges. For instance, an ATS cannot regulate the conduct of subscribers because they have no power to set rules guiding the behaviors of subscribers. Exclusion of certain subscribers from trading cannot be done on ATS as against what is obtainable in national exchanges where traders can face disciplinary actions. Individual investors and institutional investors can trade on ATS, rather than on national exchanges. The reason for this is mostly because ATS transactions do not show on national exchange order books and can, therefore, be easily shielded from public view.
Key Takeaways
Here are some key points to know about the alternative trading system;
- An alternative trading system is an electronic platform where buy and sell orders of traders are matched to counterparties
- ATS is not considered a national exchange but must be registered and approved by the SEC.
- ATSs are registered as broker-dealers and not exchanges.
Regulation ATS Explained
The regulatory framework of ATS is established by Regulation ATS as provided by the SEC. Below are some of the regulatory frameworks;
- An ATS is permitted to operate if it meets the definition of a national exchange.
- An ATS under the Exchange Act Rule 3a1-1(a) is exempted from registering as an exchange.
- ATSs are required to comply with Rules 300-303 of Regulation ATS.
- An ATS must report its books and records.
However, additional regulations have been added to Regulation ATS by the SEC to enhance the operational transparency of these platforms. One of the regulations is a mandatory requirement of ATS to file a comprehensive public disclosure.
Academics Research on Alternative Trading System (ATS)
- 10Alternative Trading Systemsand liquidity, Degryse, H., & Van Achter, M. (2003). 10 Alternative Trading Systems and liquidity.Technology and Finance: Challenges for Financial Markets, Business Strate
- Alternative trading systems: Description ofATS tradingin national marketsystemstocks, Tuttle, L. A. (2013). Alternative trading systems: Description of ATS trading in national market system stocks.Division of Economic and Risk Analysis White Paper. This paper discusses descriptive statistics on U.S. equity Alternative Trading Systems (ATSs, some of which are referred to as dark pools). The paper is intended to inform public discussion of the role and regulation of ATSs. While ATSs operate markets similar in some ways to the registered exchanges, there are important institutional differences. Although both exchanges and ATSs provide marketplaces for buyers and sellers to transact in securities, ATSs do not necessarily provide public information on the best prices available to traders within their system. They also do not set rules governing the conduct of subscribers and they perform no self-regulation, while exchanges perform all of these functions. Additionally, because ATSs are regulated as broker-dealers, they comply with a different set of regulations than traditional exchanges. Trading on ATSs regularly comprises 10-15% of U.S. equity trading volume. However, academic and public understanding of ATSs lags that of traditional exchanges partially due to a lack of publicly available data on ATSs. Using a five-day sample of regulatory data from May 7-11, 2012, this paper discusses summary statistics on ATS participation in the trading of National Market System (NMS) stocks, including common stocks and many exchange-traded products (ETPs).
- Regulating exchanges andalternative trading systems: A law and economics perspective, Macey, J. R., & O'hara, M. (1999). Regulating exchanges and alternative trading systems: A law and economics perspective.The Journal of Legal Studies,28(1), 17-54. New trading technologies are transforming securities markets, and with their rise have come important questions regarding the regulation of new and traditional trading mechanisms. This article provides a law and economics perspective on the regulation of alternative trading systems. We argue that alternative trading systems play a distinct role in the market and in particular solve the conflictofinterest problem that exists between brokers and dealers. We propose a general strategy for their regulation that incorporates this economic role. We suggest a regulatory framework that permits providers of services to opt into particular regulatory frameworks as a way of fostering innovation and competition. The functional approach we outline is consistent with the Securities and Exchange Commission's regulatory objectives of fairness, efficiency, and transparency of market transactions.
- Institutional trading and alternative trading systems, Conrad, J., Johnson, K. M., & Wahal, S. (2003). Institutional trading and alternative trading systems.Journal of Financial Economics,70(1), 99-134. We analyze the use of alternative trading systems in a large sample of institutional orders and the trades that constitute these orders. Proprietary data allow us to distinguish between orders and trades filled by day and after-hours crossing systems, electronic communication networks (ECNs), and traditional brokers. Controlling for variation in order and security characteristics, as well as endogeneity in the choice of trading venue, we find that realized execution costs are generally lower on alternative trading systems. Order handling rules and tick size changes implemented in 1997 appear to have reduced the cost advantage of trading on ECNs.
- On the road to regATS: A critical history of the regulation of automated trading systems, Domowitz, I., & Lee, R. (2001). On the road to reg ATS: A critical history of the regulation of automated trading systems.International Finance,4(2), 279-302. Automation of the trade execution process transforms the industrial structure of the trading services industry, changing the context within which trade execution services are regulated. We provide a short history of the US equity market experience as a case study of regulatory reaction and accommodation to new trading technology. Past and current approaches to the regulation of automated trading systems are described. Issues are identified that are common to a variety of international jurisdictions and to trading in financial instruments other than common stocks. The analysis emphasizes the use of the definition of an exchange for the purpose of classification and regulation of automated trading systems. The main theme, however, is regulation of market structure, defined as comprising the rules and institutions that determine competition between trading platforms.