Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; Notice of Filing of Proposed Rule Change To Adopt the CHX Liquidity Taking Access Delay, 65442-65458 [2016-22790]

Agencies

• SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 81, Number 184 (Thursday, September 22, 2016)]
[Notices]
[Pages 65442-65458]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-22790]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-78860; File No. SR-CHX-2016-16]


Self-Regulatory Organizations; Chicago Stock Exchange, Inc.; 
Notice of Filing of Proposed Rule Change To Adopt the CHX Liquidity 
Taking Access Delay

September 16, 2016.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 \2\ thereunder, notice is hereby given 
that on September 6, 2016, the Chicago Stock Exchange, Inc. (``CHX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II 
and III below, which Items have been prepared by the Exchange. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    CHX proposes to amend the Rules of the Exchange (``CHX Rules'') to 
adopt the CHX Liquidity Taking Access Delay. The text of this proposed 
rule change is available on the Exchange's Web site at https://www.chx.com/rules/proposed_rules.htm, at the principal office of the 
Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of, and basis for, the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of those statements may be examined at 
the places specified in Item IV below. The Exchange has prepared 
summaries, set forth in sections A, B and C below, of the most 
significant parts of such statements.

[[Page 65443]]

A. Self-Regulatory Organization's Statement of the Purpose of, and the 
Statutory Basis for, the Proposed Rule Change

1. Purpose
Background
    The Exchange proposes to adopt the CHX Liquidity Taking Access 
Delay (``LTAD''). LTAD is designed to neutralize microsecond speed 
advantages exploited by low-latency market participants engaged in 
latency arbitrage \3\ strategies that diminish displayed liquidity and 
impair price discovery in national market system (``NMS'') 
securities.\4\ In sum, LTAD would require all new incoming orders \5\ 
received during the Open Trading State \6\ that could immediately 
execute against one or more resting orders on the CHX book, as well as 
certain related cancel messages, to be intentionally delayed for 350 
microseconds before such delayed messages would be processed \7\ by the 
Matching System.8 9 All other messages, including liquidity 
providing orders (i.e., orders that would not immediately execute 
against resting orders) and cancel messages for resting orders, would 
be immediately processed without delay. LTAD will not delay any 
outbound messages or market data.
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    \3\ As used herein, ``latency arbitrage'' means the practice of 
exploiting disparities in the price of a security or related 
securities that are being traded in different markets by taking 
advantage of the time it takes to access and respond to market 
information. Given its emphasis on speed, latency arbitrage has 
resulted in a well-documented and escalating technology race among 
certain market participants seeking to obtain ever smaller speed 
advantages. See Eric Budish, Peter Cramton and John Shim, ``The 
High-Frequency Trading Arms Race: Frequent Batch Auctions as a 
Market Design Response,'' Quarterly Journal of Economics, Vol. 
130(4), November 2015 (``Budish Paper''); see also e.g., Elaine Wah 
and Michael Wellman. 2013. ``Latency Arbitrage, Market 
Fragmentation, and Efficiency: A Two-Market Model.'' 14th ACM 
Conference on Electronic Commerce, June. In recent years, a 
significant amount of academic research has been done regarding the 
impact of latency arbitrage on the efficiency of securities markets. 
See id. Many of these studies have suggested that latency arbitrage 
exacts a ``tax'' on liquidity provision that dissuades liquidity 
providers from displaying large aggressively priced orders for fear 
of their stale orders being taken by latency arbitrageurs before the 
liquidity providers have had the chance to adjust such orders when 
reacting to the same market data. See Eric Budish, Comment letter 
regarding ``Investors' Exchange LLC Form 1 Application (Release No. 
34-75925; File No. 10-222)'' dated February 5, 2016 (``Budish 
Letter'').
    \4\ The Exchange notes that while LTAD is designed to neutralize 
microsecond speed advantages, liquidity providers would still be 
required to obtain speed capabilities fast enough to take advantage 
of the LTAD.
    \5\ ``New incoming orders'' are orders received by the Matching 
System for the first time. As discussed below, LTAD will not apply 
to other situations where existing orders or portions thereof are 
treated as incoming orders, such as (1) resting orders that are 
price slid into a new price point pursuant to the CHX Only Price 
Sliding or Limit Up-Limit Down Price Sliding Processes and (2) 
unexecuted remainders of routed orders released into the Matching 
System. See CHX Article 1, Rule 2(b)(1)(C); see also CHX Article 20, 
Rule 2A(b); see also CHX Article 20, Rule 8(b)(7). Incidentally, the 
Exchange is proposing to amend CHX Article 20, Rule 8(a)(7), which 
describes how unexecuted remainders of routed orders are handled by 
the Matching System, to delete the word ``new'' from the last 
sentence, so that the rule provides, in pertinent part, that if no 
balance exists at the time a part of an unexecuted remainder of a 
routed order is returned to the Matching System, it shall be treated 
an incoming order.
    \6\ See CHX Article 1, Rule 1(qq) defining ``Open Trading 
State.''
    \7\ For ease of reference, ``processed'' means executing 
instructions contained in a message, including, but not limited to, 
permitting an order to execute within the Matching System pursuant 
to the terms of the order or cancelling an existing order, whereas 
``evaluate'' means the Matching System determining whether a message 
should be diverted into LTAD, as described below.
    \8\ The Matching System is an automated order execution system, 
which is a part of the Exchange's ``Trading Facilities,'' as defined 
under CHX Article 1, Rule 1(z).
    \9\ As discussed below, the Exchange submits that LTAD is a de 
minimis intentional access delay in that it is so short as to not 
frustrate the purposes of Rule 611 of Regulation NMS by impairing 
fair and efficient access to an exchange's quotations. See 
Securities Exchange Act Release No. 78102 (June 17, 2016), 81 FR 
40785 (June 23, 2016) (``Final Interpretation''). Thus, the 
Exchange's quotations would continue to be ``immediately'' 
accessible and protected pursuant to Rule 611. See 17 CFR 
242.600(b)(3) defining ``automated quotation''; see also 17 CFR 
242.600(b)(58) defining ``protected quotation''; see also infra 
Section 3(b).
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    LTAD is a direct response to recent declines in CHX volume and 
liquidity in the SPDR S&P 500 trust exchange-traded fund (``SPY''),\10\ 
which the Exchange attributes to latency arbitrage activity in SPY 
first observed at CHX in January 2016 (``SPY latency arbitrage 
activity'').\11\ Specifically, based on its review of unusual messaging 
patterns in SPY during the relevant period, corroborating Participant 
feedback and analysis of market data,\12\ the Exchange believes that 
SPY latency arbitrage has caused CHX liquidity providers to 
dramatically reduce displayed liquidity in SPY (and at times withdraw 
from the market altogether), which, given CHX's significant 
contribution to overall volume and liquidity in SPY prior to the 
declines,\13\ materially decreased liquidity in SPY marketwide, as 
discussed below.\14\
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    \10\ The Exchange believes that much of the CHX liquidity in SPY 
and other S&P 500-correlated securities is provided as part of an 
arbitrage strategy between CHX and the futures markets, whereby 
liquidity providers utilize, among other things, proprietary 
algorithms to price and size resting orders on CHX to track index 
market data from a derivatives market (e.g., E-Mini S&P traded on 
the Chicago Mercantile Exchange's Globex trading platform). As such, 
an exchange could not make related adjustments to these special 
orders on behalf of liquidity providers pursuant to an order type, 
such as pegged orders benchmarked to the NBBO. Compare infra note 
16.
    \11\ As discussed in detail under Appendix A below, prior to the 
beginning of the SPY latency arbitrage activity in January 2016, CHX 
volume and liquidity in SPY constituted a material portion of 
overall volume and liquidity in SPY marketwide. For example, the CHX 
Market Share in SPY as a percentage of Total Volume decreased from 
5.73% in January 2016 to 0.57% in July 2016, while the Control 
Securities did not experience similar declines. See infra note 12; 
see also infra Appendix A; see also infra Appendix B Calculation Set 
1a. Also, the Time-weighted Average CHX Size At The NBBO in SPY 
relative to the total NMS Size At The NBBO in SPY decreased from 
44.36% in January 2016 to 3.39% of the total NMS Size At The NBBO in 
SPY in July 2016, while the Control Securities did not experience 
similar declines. See infra note 12; see also infra Appendix A; see 
also infra Appendix B Calculations Sets 3a and 4a.
    \12\ A detailed analysis (``CHX ETF Analysis'') of the impact of 
latency arbitrage on displayed liquidity in SPY at CHX, for the 
period of August 2015 through July 2016 (``Analysis Period''), may 
be found under Appendix A. The market data utilized by the CHX ETF 
Analysis, as well as defined terms and notes, may be found under 
Appendix B.
    \13\ See supra note 11.
    \14\ See infra Appendix A.
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    The Exchange believes that the best way to minimize the 
effectiveness of latency arbitrage strategies on CHX with respect to 
resting limit orders is to implement an asymmetric delay, such as LTAD, 
to deemphasize speed as a key to trading success.\15\ By delaying 
liquidity taking orders, and not delaying liquidity providing orders 
and related adjustment messages, LTAD would give liquidity providers a 
small amount of additional time, the same length as the Investors 
Exchange LLC (``IEX'') POP/coil delay (``IEX Delay'') recently approved 
by the Commission,\16\ to cancel or adjust resting orders on the CHX 
book to comport to the most recent market data before latency 
arbitrageurs could take such orders at potentially ``stale'' 
prices.\17\ As the Commission noted in the IEX Approval Order, a 
symmetric delay that delays all inbound messages, such as the IEX 
Delay, would be ineffective in protecting resting limit

[[Page 65444]]

orders from latency arbitrage.\18\ Thus, the Exchange believes that 
LTAD will enhance displayed liquidity and price discovery in NMS 
securities without adversely affecting the ability of virtually all 
market participants, other than latency arbitrageurs, to access 
liquidity at CHX.\19\
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    \15\ See Mary Jo White, Chair, Securities and Exchange 
Commission, Speech at Sandler O'Neil & Partners L.P. Global Exchange 
and Brokerage Conference (June 5, 2014).
    \16\ See Securities Exchange Act Release No. 78101 (June 17, 
2016), 81 FR 41141 (June 23, 2016) (``IEX Approval Order''). Unlike 
LTAD, the IEX Delay will delay all inbound order-related messages 
from IEX Users, outbound message confirmations to IEX Users, and 
outbound market data disseminated through IEX's proprietary data 
feed. See IEX Approval Order at 41154. By not delaying inbound 
market data, IEX would be able to reprice its resting pegged orders 
to track changes to the NBBO before latency arbitrageurs could 
execute against such pegged orders at potentially stale prices, 
which facilitates the ability of IEX to comply with its rules 
regarding the repricing of pegged orders. See IEX Approval Order at 
41155.
    \17\ In discussing possible alternatives to a frequent batch 
auction model for trading securities, the Budish Paper provides that 
``the asymmetric delay eliminates sniping and stops the arms race.'' 
See Budish Paper at 1612.
    \18\ See IEX Approval Order, supra note 16, at 41157.
    \19\ Based on the Exchange's analysis of cancel activity in SPY 
at CHX for the period starting in May 2016 through July 2016, the 
Exchange believes that if LTAD had been implemented during that time 
period, out of a total of 18,316 partially-executed orders in SPY, 
20 liquidity taking orders not attributed to latency arbitrage 
activity would have not been executed, a de minimis number in the 
light of the enhanced liquidity and price discovery afforded by 
LTAD. See infra Appendix C.
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    Additionally, the Exchange notes that adopting a symmetric delay 
and order types that would permit the Exchange to reprice resting 
orders based on undelayed market data (e.g., pegged orders), such as 
the IEX Delay, would not be practical in addressing latency arbitrage 
with respect to limit orders because the liquidity provision strategies 
utilized by CHX liquidity providers in SPY, which provide valuable 
liquidity to the market overall,\20\ require cancellations or 
adjustments to resting limit orders pursuant to proprietary algorithms 
held by the CHX liquidity providers that could not be adequately 
replicated by CHX.\21\
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    \20\ See supra note 12; see also infra Appendices A and B.
    \21\ See supra note 10.
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    In light of the above, the Exchange submits that the proposed rules 
for LTAD are designed to operate in a manner that is consistent with 
the Act in that they are designed to protect investors and the public 
interest, are not designed to permit unfair discrimination, and would 
not impose any unnecessary or inappropriate burden on competition.\22\ 
The Exchange now proposes the following amendments to the CHX Rules to 
implement LTAD.
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    \22\ See infra Section 3(b).
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Amended Article 20, Rule 8 (Operation of the CHX Matching System)
    Proposed Article 20, Rule 8(h) provides rules that comprehensively 
describe LTAD. Specifically, proposed paragraph (h) begins by stating 
that after initial receipt \23\ of a new incoming message, the Matching 
System will evaluate \24\ the message to determine whether it is a 
``delayable message,'' as defined under proposed paragraph (h)(1) 
below. For the purposes of such an evaluation only, the Matching System 
shall not consider Match Trade Prevention (``MTP''), as described under 
current Article 1, Rule 2(b)(3)(F).\25\ If not delayable, the Matching 
System will immediately process the message without delay. Proposed 
paragraph (h)(1) defines ``delayable message'' and provides that 
delayable messages shall only include the following:
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    \23\ As used herein, ``initial receipt'' means the time at which 
the Exchange receives a message and assigns the message a unique 
sequence number, which the Exchange utilizes to determine, among 
other things, message processing order and ranking on the CHX book. 
See CHX Article 20, Rule 8(b).
    \24\ See supra note 7.
    \25\ The purpose of ignoring MTP in LTAD evaluation is to 
provide a previously delayed order that would not have triggered MTP 
an opportunity to execute against the resting order before the newer 
incoming order would cancel the resting order after release from 
LTAD. The Exchange is proposing unrelated modifications to MTP to 
contemplate LTAD, as discussed below.
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    (A) New incoming orders received during the Open Trading State \26\ 
that would take liquidity from the CHX book.
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    \26\ The Exchange notes that LTAD would not apply during a SNAP 
Cycle, as described under CHX Article 18, Rule 1, as orders are not 
immediately executable at that time.
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    (B) Cancel and cancel/replace messages for delayed orders that have 
not yet been released from LTAD.\27\
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    \27\ As noted later under proposed paragraph (h), a delayed 
message may only be delayed once and, thus, the replace portion of a 
delayed cancel/replace message shall not be diverted into LTAD upon 
release in the event that it would take liquidity from the CHX book.

    (C) The replace portion of a cancel/replace message where the 
cancel portion cancels a resting order and the replace portion would 
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take liquidity from the CHX book.

The Exchange notes that the purpose of delaying the aforementioned 
cancel and cancel/replace messages is to minimize gaming opportunities 
by requiring the delayed order to interact with the CHX book before it 
is eligible for cancellation.
    Mechanically, upon initial receipt of a new incoming message, the 
Matching System would assign the message a unique sequence number, as 
it does currently, which, in addition to establishing processing and 
execution priority, will serve as the starting point for the Fixed LTAD 
Period, as described below. The Matching System would then initially 
evaluate the message to determine whether it is a delayable 
message.\28\ For example, a new incoming limit order marked Post Only 
\29\ that could not take liquidity from the CHX book would not be a 
delayable message because it could not immediately execute against one 
or more resting orders on the CHX book. In such a case, the undelayed 
Post Only order would be immediately cancelled by the Matching System 
if it would immediately match with a resting order. Similarly, a new 
incoming order marked CHX Only \30\ that would trade-through a 
protected quotation of an external market would not be a delayable 
message as it would be price slid to a permissible price.\31\ However, 
a new incoming order that could immediately execute against a resting 
order, but for the fact that MTP would be triggered and prevent a 
match, would be considered a delayable message, as MTP is ignored for 
the purposes of LTAD evaluation only.\32\
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    \28\ The Exchange notes that the Matching System processes 
messages for a given security serially. Thus, the length of time it 
takes for a message to be evaluated and/or processed by the Matching 
System after initial receipt is herein called ``variable message 
queuing delay,'' as the actual length of the delay depends on the 
number of precedent messages that have yet to be evaluated and/or 
processed by the Matching System and are residing in the ``Inbound 
Queue.'' The length of time it takes for a message to be evaluated 
and/or processed by the Matching System is herein called ``system-
processing delay.''
    \29\ See CHX Article 1, Rule 2(b)(1)(D) defining ``Post Only.''
    \30\ See CHX Article 1, Rule 2(b)(1)(C) defining ``CHX Only.''
    \31\ See CHX Article 20, Rule 5(a)(2).
    \32\ See supra note 25.
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    Proposed paragraph (h) continues by providing that if a message is 
delayable, the message will be diverted into the LTAD queue and will 
remain delayed until it is released for processing. A delayed message 
shall become releasable 350 microseconds after initial receipt by the 
Exchange (``Fixed LTAD Period''),\33\ but shall only be processed after 
the Matching System has evaluated and processed, if applicable,\34\ all 
messages in the security received by the Exchange during the Fixed LTAD 
Period for the delayed message. Thus, a message may be delayed for 
longer than the Fixed LTAD Period depending on the then-current 
messaging volume in the security.\35\ The Matching System

[[Page 65445]]

will utilize a new market snapshot to process a released order.\36\ 
Also, a delayed message shall retain its original sequence number and 
may only be delayed once. In addition, LTAD shall apply to all 
delayable messages submitted by any Participant for a security traded 
on the Exchange that is subject to LTAD. The Exchange may activate or 
deactivate LTAD per security with notice to Participants.\37\
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    \33\ In the event that then-current messaging volume results in 
a delayable message being evaluated after 350 microseconds from 
initial receipt, the delayable message shall be diverted into LTAD 
and be immediately releasable. This will ensure that messages 
received during the Fixed LTAD Period for a delayed message are 
evaluated and processed, if applicable, before the delayable message 
is released.
    \34\ For example, an order that could not take liquidity from 
the CHX book would not be delayed and would be immediately 
processed, whereas an order that could take liquidity from the CHX 
book would be delayed and would not be immediately processed.
    \35\ In the event a releasable message is awaiting other 
messages received during its Fixed LTAD Period to be evaluated and 
processed, if applicable, the releasable message would be subject to 
an additional unintentional variable delay that is a function of the 
then-current messaging volume in the security. See supra note 28; 
see also supra note 33; see also infra Examples 1-3.
    \36\ The purpose of a new market snapshot is to ensure that the 
released order is processed in a manner consistent with federal 
securities rules and regulations, such as Regulation NMS and 
Regulation SHO.
    \37\ As of the date of this filing, the Exchange anticipates 
applying LTAD to all securities traded on CHX. In the event the 
Exchange decides to activate or deactivate LTAD for certain 
securities, the Exchange will communicate the list of securities for 
which LTAD will be applied and/or the securities for which LTAD will 
not be applied, as well as the effective date(s) of such change(s), 
through a Customer Service Notification. Any change to the list of 
LTAD securities shall not be effective prior to the trading day 
following the date of the Customer Service Notification and shall 
only be effective as of the beginning of the relevant trading day.
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    The Exchange also proposes to make corresponding amendments to 
current Article 20, Rule 8(d) and (f) to contemplate LTAD. 
Specifically, the Exchange proposes to add the clause ``subject to 
paragraph (h) below'' at the end of current paragraph (d)(1) so that 
amended paragraph (d)(1) provides as follows:

    Except for certain orders which shall be executed as described 
in Rule 8(e), below, an incoming order shall be matched against one 
or more resting orders in the Matching System, in the order in which 
the resting orders are ranked on the CHX book, pursuant to Rule 8(b) 
above, at the Working Price of each resting order, as defined under 
Article 1, Rule 1(pp), for the full amount of shares available at 
that price, or for the size of the incoming order, if smaller; 
subject to paragraph (h) below.

The Exchange also proposes to adopt paragraph (f)(3) to provide that 
certain cancel messages for an order in LTAD shall be handled as 
described under proposed paragraph (h). Incidentally, the Exchange 
proposes to replace the semi-colon and the word ``and'' at the end of 
current paragraph (f)(1) with a period.
    Moreover, proposed paragraph (h)(2) describes how LTAD would 
interact with the Exchange's current order routing protocol and 
provides that the portion of a Routable Order \38\ that is to be routed 
away, pursuant to current Article 19, Rule 3(a), shall be immediately 
routed without delay; provided that the entire unrouted balance of the 
Routable Order will be diverted into LTAD upon reaching the price point 
at which the unrouted balance of the Routable Order would become a 
delayable message (i.e., would take liquidity from the CHX book), 
pursuant to proposed paragraph (h)(1)(A).
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    \38\ See CHX Article 1, Rule 1(oo).
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    Currently, the Exchange determines where and how to route an order 
on a price point-by-price point basis.\39\ That is, the Exchange does 
not aggregate all protected quotations and resting liquidity through 
multiple price points in making a single order routing decision.\40\ 
Thus, to the extent that an incoming order could take liquidity from 
the CHX book at a price worse than an away protected quotation (e.g., 
incoming sell order at $10.00/share; CHX Best Bid at $10.00/share and 
NBB at $10.01/share), the Matching System would not consider the fact 
that the incoming order could take liquidity from the CHX book at the 
time the Matching System is evaluating the better priced protected 
quotation. As such, LTAD may result in a portion of a Routable Order 
being immediately routed away and the unrouted remainder being delayed.
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    \39\ See Exchange Act Release No. 74487 (March 12, 2015), 80 FR 
14193 (March 18, 2015) (SR-CHX-2015-02).
    \40\ See id.
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Amended Routing Protocol
    In light of the possible bifurcation of a Routable Order into an 
immediately routed portion and a delayed unrouted portion and the fact 
that the Exchange does not currently utilize any Router Feedback \41\ 
to augment protected quotations,\42\ LTAD could result in a single 
order being routed twice to satisfy the same protected quotation. In 
order to eliminate this inefficiency, the Exchange proposes to amend 
its current order routing protocol to adopt a single type of Router 
Feedback called Immediate Feedback to be applied on an order-by-order 
basis only.\43\
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    \41\ ``Router Feedback'' refers to the use of routed orders 
(``Feedback Orders'') to augment protected quotations for the 
purposes of calculating the NBBO. See Securities Exchange Act 
Release No. 74075 (January 15, 2015), 80 FR 3693 (January 23, 2015) 
(SR-BYX-2015-03).
    \42\ The consolidated market data disseminated by the securities 
information processors (``SIPs'') are the only market data feeds 
utilized by the Exchange for the handling, execution and routing of 
orders, as well as for the regulatory compliance processes related 
to those functions. See CHX Article 1, Rule 4. Also, the Exchange 
does not currently ignore or modify SIP quote data for away markets 
under any circumstances where the SIP data feed shows an uncrossed 
market. See Exchange Act Release No. 74357 (February 24, 2015), 80 
FR 11252 (March 2, 2015) (SR-CHX-2015-01); see also Securities 
Exchange Act Release No. 72711 (July 29, 2014), 79 FR 45570 (August 
5, 2014) (SR-CHX-2014-10).
    \43\ Bats BYX utilizes three different types of Router Feedback 
in its calculation of the NBBO, which includes Immediate Feedback, 
which is described as follows: ``Where BATS Trading routes an order 
to a venue with a protected quotation using Smart Order Routing (a 
``Feedback Order''), the number of shares available at that the 
venue is immediately decreased by the number of shares routed to the 
venue at the applicable price level.'' See SR-BYX-2015-03, supra 
note 41, at 3695. Also, all Feedback expires as soon as: (i) One 
second passes; (ii) the exchange receives new quote information; or 
(iii) the exchange receives updated Feedback information. See id.
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    Specifically, Immediate Feedback would permit the Exchange's 
Routing System to decrease the number of shares available at an away 
market by an amount equal to the size of the immediately routed portion 
of the Routable Order, on an order-by-order basis, with such feedback 
expiring as soon as: (i) One second passes or (ii) the Exchange 
receives new quote information from the away market.\44\ This would 
permit the Exchange to utilize Immediate Feedback to ignore the 
protected quotation to which the immediately routed portion was routed 
when the unrouted delayed portion is released from LTAD, thereby 
preventing double routing to satisfy the same protected quotation.\45\
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    \44\ Given the length of the Fixed LTAD Period, the Exchange 
notes that it is unlikely that Immediate Feedback would expire due 
to one second passing without new quote information.
    \45\ Given the length of the Fixed LTAD Period, it is unlikely 
that the Exchange would receive a confirmation from the away market 
prior to the unrouted delayed portion being released from LTAD.
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    Examples 1-3 illustrate the operation of LTAD. Examples 3 and 4 
illustrate the operation of the proposed amended routing protocol.
Amended Article 1, Rule 2(b)(3)(F) (Match Trade Prevention)
    Current Article 1, Rule 2(b)(3)(F) describes the MTP modifier, 
which prevents matches between orders that originate from the same MTP 
Trading Group or MTP sublevel thereunder.\46\ Also, an order sender 
must designate one of the following MTP Actions for each order, with 
the MTP Action noted on the incoming order controlling the MTP 
interaction:
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    \46\ See Securities Exchange Act Release No. 71216 (December 31, 
2013), 79 FR 883 (January 7, 2014) (SR-CHX-2013-23); see also 
Securities Exchange Act Release No. 70948 (November 26, 2013), 78 FR 
72731 (December 3, 2013) (SR-CHX-2013-20).

    MTP Cancel Incoming (``N''): An incoming limit or market order 
marked ``N'' will not execute against opposite side resting interest 
originating from the same MTP Trading Group or MTP sublevel, if 
applicable. Only the incoming order will be cancelled pursuant to 
MTP.
    MTP Cancel Resting (``O''): An incoming limit or market order 
marked ``O'' will not execute against opposite side resting interest 
originating from the same MTP Trading

[[Page 65446]]

Group or MTP sublevel, if applicable. Only the resting order will be 
cancelled pursuant to MTP.
    MTP Cancel Both (``B''): An incoming limit or market order 
marked ``B'' will not execute against opposite side resting interest 
originating from the same MTP Trading Group or MTP sublevel, if 
applicable. The entire size of both orders will be cancelled 
pursuant to MTP.


    Given that LTAD may result in newer orders (i.e., orders with lower 
sequence numbers) becoming resting orders prior to older orders being 
released from LTAD,\47\ the Exchange proposes to amend current Article 
1, Rule 2(b)(3)(F)(iii)(a) and (b), which describe MTP Actions ``N'' 
and ``O'' respectively, to provide that the newer of the contra-side 
orders, as opposed to the incoming order if it is the older order, 
would be cancelled if the incoming order is marked ``N,'' and the older 
of the contra-side orders, as opposed to the resting order if it is the 
newer order, would be cancelled if the incoming order is marked ``O.'' 
Moreover, given that a price slid order that triggers MTP is not always 
the newer order \48\ and because the Exchange wishes to maintain the 
current handling of MTP when it is triggered by a price slid order, the 
Exchange proposes to add clauses to the end of current subparagraphs 
(a) and (b) that preserve that current handling. Thus, amended 
subparagraphs (a) and (b) provide as follows:
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    \47\ Currently, a new incoming order that triggers MTP is always 
newer than the resting contra-side order. However, LTAD may result 
in the newer of the contra-side orders being the resting order and 
the older order being the incoming order. See infra Example 5.
    \48\ See Example 4 under SR-CHX-2013-20.
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    (a) MTP Cancel New (``N''): An incoming limit or market order 
marked ``N'' will not execute against opposite side resting interest 
originating from the same MTP Trading Group or MTP sublevel, if 
applicable. Only the newer order will be cancelled pursuant to MTP; 
provided that the incoming order will be cancelled, even if it is not 
the newer order, in the event MTP is triggered by the incoming order 
being price slid pursuant to the CHX Only Price Sliding Processes.
    (b) MTP Cancel Old (``O''): An incoming limit or market order 
marked ``O'' will not execute against opposite side resting interest 
originating from the same MTP Trading Group or MTP sublevel, if 
applicable. Only the older order will be cancelled pursuant to MTP; 
provided that the resting order will be cancelled, even if it is not 
the older order, in the event MTP is triggered by the incoming order 
being price slid pursuant to the CHX Only Price Sliding Processes.
    Example 5 below illustrates how the amended MTP would operate in 
the context of LTAD.
Examples
    The following Examples are illustrative of LTAD and related 
amendments to existing functionality, but do not exhaustively depict 
every possible scenario that may arise under LTAD. Moreover, the 
Examples do not necessarily depict the actual technical processes of 
prioritizing messages and executing orders.
    Example 1: LTAD. Assume that LTAD is operational, all messages are 
for security XYZ and all orders are routable. Assume that the system-
processing delay \49\ is 50 microseconds.\50\ Assume then at 
9:59:59.999999, the NBBO is 10.00 x 10.01, the Inbound Queue and the 
LTAD queue are empty and the CHX book is as follows:
---------------------------------------------------------------------------

    \49\ See supra note 28.
    \50\ The Exchange does not represent that actual system-
processing delay is at or near 50 microseconds or that unintentional 
delays do not exist elsewhere in the Matching System processes. The 
figure is being utilized for demonstrative purposes only.

                            Fig 1a--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Empty.....................................  Order A: 1000 @10.01.
------------------------------------------------------------------------

    Assume then that at 10:00:00.000000, the Exchange receives the 
following order:

                          Fig 1b--Inbound Queue
------------------------------------------------------------------------
              Initial receipt                          Message
------------------------------------------------------------------------
10:00:00.0000000..........................  Order B: Buy 1000 @10.01.
------------------------------------------------------------------------

    Under this Example 1, Order B would be immediately evaluated and 
diverted into LTAD because it is a delayable message as it could 
execute against Order A. Due to the system-processing delay, Order B 
would be diverted into LTAD at 10:00:00.000050 and releasable at 
10:00:00.000350. The result is that the Inbound Queue would be empty 
and the LTAD queue would be as follows:

                           Fig 1c--LTAD Queue
------------------------------------------------------------------------
              Releasable time                          Message
------------------------------------------------------------------------
10:00:00.000350...........................  Order B: Buy 1000 @10.01.
------------------------------------------------------------------------

    Example 2: Execution Priority. Assume the same as Example 1 and the 
NBBO is still 10.00 x 10.01 with CHX being the only market at the NBO. 
Assume then that the Matching System receives the following new 
messages in security XYZ:

                          Fig 2a--Inbound Queue
------------------------------------------------------------------------
              Initial receipt                          Message
------------------------------------------------------------------------
10:00:00.000265...........................  Cancel Order A.
10:00:00.000305...........................  Order C: Sell 1000 @10.02.
10:00:00.000310...........................  Order D: Buy 1000 @10.01.
10:00:00.000325...........................  Cancel Order B.
10:00:00.000355...........................  Order E: Sell 1000 @10.01.
------------------------------------------------------------------------

    Under this Example 2:
     Cancel Order A would be evaluated and processed at 
10:00:00.000265 without being diverted into LTAD as it would cancel a 
resting order and is not a delayable message. However, due to the 
system-processing delay, Order A would actually be cancelled at 
10:00:00.000315 and the CHX book would become empty.
     Order C would then be evaluated at 10:00:00.000315, due to 
the variable message queuing delay,\51\ and then immediately processed 
without being diverted into LTAD as it adds liquidity to the CHX book 
and it is not a delayable message. However, due to the system-
processing delay, Order C would actually post to the CHX book at 
10:00:00.000365 and the CHX book would be as follows:
---------------------------------------------------------------------------

    \51\ See supra note 28.

                            Fig 2b--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Empty.....................................  Order C: 1000 @10.02.
------------------------------------------------------------------------

     While Order C was being evaluated and processed by the 
Matching System, Order B became releasable from the LTAD queue at 
10:00:00.000350. However, given that the Matching System processes 
messages serially,\52\ the Matching System would not consider releasing 
Order B until after Order C had been processed at 10:00:00.000365, at 
which point it would be handled as follows:
---------------------------------------------------------------------------

    \52\ See id.
---------------------------------------------------------------------------

    [cir] At 10:00:00.000365, the Matching System would compare the 
releasable time of Order B to the initial receipt time of the message 
at the top of the Inbound Queue: Order D. Since Order D was received 
during the Fixed LTAD Period for Order B, Order D would be evaluated 
before releasing Order B and

[[Page 65447]]

immediately processed without being diverted into LTAD as it adds 
liquidity to the CHX book and is not a delayable message. However, due 
to the system-processing delay, Order D would actually post to the CHX 
book at 10:00:00.000415. The result is that the NBBO would become 10.01 
x 10.02 and the CHX book would be as follows:

                            Fig 2c--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Order D: 1000 @10.01......................  Order C: 1000 @10.02.
------------------------------------------------------------------------

    [cir] At 10:00:00.000415, the Matching System would then compare 
the releasable time of Order B to the initial receipt time of the next 
message at the top of the Inbound Queue: Cancel Order B. Since Cancel 
Order B was received when Order B was in the LTAD queue, Cancel Order B 
would be diverted into LTAD as it is a cancel message for an order that 
has yet to be released from LTAD. However, due to the system-processing 
delay, Cancel Order B would be diverted into LTAD at 10:00:00.000465 
and releasable at 10:00:00.000675. The result is that the LTAD queue 
would be as follows:

                           Fig 2d--LTAD Queue
------------------------------------------------------------------------
             Releaseable time                          Message
------------------------------------------------------------------------
10:00:00.000350...........................  Order B: Buy 1000 @10.01.
10:00:00.000675...........................  Cancel Order B.
------------------------------------------------------------------------

    [cir] At 10:00:00.000465, the Matching System would then compare 
the releasable time of Order B to the initial receipt time of the next 
message at the top of the Inbound Queue: Order E. However, given that 
Order E was received after the Fixed LTAD Period for Order B had 
expired, the Matching System would release Order B before evaluating 
Order E. Due to the system-processing delay, Order B would actually 
post to the CHX book at 10:00:00.000515. Also, given that Order B was 
initially received before Order D, Order B would receive execution 
priority over Order D, pursuant to Article 20, Rule 8(b)(1). The result 
is that the CHX book would be as follows:

                            Fig 2e--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Order B: 1000 @10.01......................  Order C: 1000 @10.02.
Order D: 1000 @10.01......................  ............................
------------------------------------------------------------------------

     Order E would then be evaluated at 10:00:00.000515, due to 
the variable message queuing delay, and since it would execute against 
Order B, it would be diverted into LTAD at 10:00:00.000565, due to the 
system-processing delay, and releasable at 10:00:00.000705. The result 
is that the LTAD queue would be as follows:

                           Fig 2f--LTAD Queue
------------------------------------------------------------------------
              Releasable time                          Message
------------------------------------------------------------------------
10:00:00.000675...........................  Cancel Order B.
10:00:00.000705...........................  Order E: Sell 1000 @10.01.
------------------------------------------------------------------------

     Cancel Order B would then be released from LTAD at 
10:00:00.000675, as there are no messages received during its Fixed 
LTAD Period in the Inbound Queue. Thus, Cancel Order B would be 
processed and Order B would be cancelled at 10:00:00.000725, due to the 
system-processing delay. The result is that the CHX Book and the LTAD 
queue would be as follows:

                            Fig 2g--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Order D: 1000 @10.01......................  Order C: 1000 @10.02.
------------------------------------------------------------------------


                           Fig 2h--LTAD Queue
------------------------------------------------------------------------
              Releasable time                          Message
------------------------------------------------------------------------
10:00:00.000705...........................  Order E: Sell 1000 @10.01.
------------------------------------------------------------------------

     Order E would then be released from LTAD at 
10:00:00.000725, as the Matching System was processing Cancel Order B 
when Order E became releasable at 10:00:00.000705. Order E would then 
be processed and fully execute against Order D at $10.01/share at 
10:00:00.000775, due to the system-processing delay. The result is that 
the Inbound Queue and the LTAD queue would be empty and the CHX Book 
would be as follows:

                            Fig 2h--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Empty.....................................  Order C: 1000 @10.02.
------------------------------------------------------------------------

    Example 3: Post Only and Routing--Immediate Feedback. Assume the 
same as Example 2 and that the NBBO is 10.01 x 10.02 with only one 
market (``Away Market A1'') displaying 1,000 shares at the 
NBB (``Protected Bid A1''). Assume also that there are no 
Protected Bids at $10.00. Assume then that the Matching System receives 
the following new messages in security XYZ:

                          Fig 3a--Inbound Queue
------------------------------------------------------------------------
              Initial receipt                          Message
------------------------------------------------------------------------
10:00:00.000800...........................  Cancel Order C.
10:00:00.001000...........................  Order F: Buy 1000 @10.00.
10:00:00.001010...........................  Order G: Sell 2000 @9.99.
10:00:00.001020...........................  Order H: Sell 2000 @9.99.
10:00:00.001030...........................  Cancel Order F.
10:00:00.001040...........................  Order I: Post Only Buy 1000
                                             @10.00.
------------------------------------------------------------------------

    Under this Example 3:
     Cancel Order C would be evaluated at 10:00:00.000800 and 
then immediately processed without being diverted into LTAD as it would 
cancel a resting order and is not a delayable message. However, due to 
the system-processing delay, Order C would actually be cancelled at 
10:00:00.000850 resulting in the CHX Book becoming empty.
     Order F would then be evaluated and processed at 
10:00:00.001000 without being diverted into LTAD as it would provide 
liquidity and is not a delayable message. However, due to the system-
processing delay, Order F would actually post to the CHX book at 
10:00:00.001050. The result is that the CHX Book would be as follows:

                            Fig 3b--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Order F: 1000 @10.00......................  Empty.
------------------------------------------------------------------------

     Order G would then be evaluated at 10:00:00.001050, due to 
variable message queuing delay. Pursuant to the Exchange's routing 
protocol, the Exchange would immediately route 1,000 shares of Order G 
priced at 10.01/share to satisfy Protected Bid A1.\53\ 
Moreover, since the unrouted 1000 shares of Order G could execute 
against Order F at 10.00, the unrouted 1000 shares of Order G would be 
diverted into LTAD at 10:00:00.001100, due to system-processing delay, 
and releasable at 10:00:00.001360. The result is that the LTAD queue 
would be as follows:
---------------------------------------------------------------------------

    \53\ The Exchange notes that the time it takes for the Exchange 
to receive confirmation from the away market for a routed order is 
much longer than the proposed 350 microsecond LTAD. Thus, it is 
highly unlikely that the Exchange would receive an execution report 
from the away market before a delayed unrouted portion is released 
from LTAD. See supra notes 44 and 45.

[[Page 65448]]



                           Fig 3c--LTAD Queue
------------------------------------------------------------------------
              Releasable time                          Message
------------------------------------------------------------------------
10:00:00.001360...........................  Order G: Sell 1000 @9.99.
------------------------------------------------------------------------

     Order H would then be evaluated at 10:00:00.001100, due to 
variable message queuing delay. Given that Order H is virtually 
identical to Order G and that the proposed Immediate Feedback is only 
applied on an order-by-order basis, Order H would be handled exactly as 
Order G. Specifically, the Exchange would immediately route 1000 shares 
of Order H priced at 10.01/share to satisfy Protected Bid 
A1. Moreover, since the unrouted 1000 shares of Order H 
could execute against Order F at 10.00, the unrouted 1000 shares of 
Order H would be diverted into LTAD at 10:00:00.001150, due to system-
processing delay, and releasable at 10:00:00.001370. The result is that 
the LTAD queue would be as follows:

                           Fig 3d--LTAD Queue
------------------------------------------------------------------------
              Releasable time                          Message
------------------------------------------------------------------------
10:00:00.001360...........................  Order G: Sell 1000 @9.99.
10:00:00.001370...........................  Order H: Sell 1000 @9.99.
------------------------------------------------------------------------

     Cancel Order F would then be evaluated at 10:00:00.001150, 
due to variable message queuing delay, but would be immediately 
processed without being diverted into LTAD as it would cancel a resting 
order and is not a delayable message. However, due to the system-
processing delay, Order F would actually be cancelled at 
10:00:00.001200. The result is that the CHX book would become empty.
     Order I would then be evaluated at 10:00:00.001200, due to 
variable message queuing delay, but would be immediately processed 
without being diverted into LTAD as it would provide liquidity and is 
not a delayable message. However, due to the system-processing delay, 
Order I would actually post to the CHX book at 10:00:00.001250. The 
result is that the CHX book would be as follows:

                            Fig 3e--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Order I: Post Only 1000 @10.00............  Empty.
------------------------------------------------------------------------

     Unrouted remainder of Order G would be released from LTAD 
at 10:00:00.001360, as all messages received during the Fixed LTAD 
Period for Order G have already been processed.\54\ Thus, Order G would 
be processed and given the Immediate Feedback received from the routed 
portion of Order G and the fact that the Immediate Feedback had not 
expired, the unrouted remainder of Order G would fully execute against 
Order I at 10.00/share \55\ at 10:00:00.001410, due to system-
processing delay.\56\ The result is that the CHX book would become 
empty.
---------------------------------------------------------------------------

    \54\ See id.
    \55\ See CHX Article 20, Rule 8(d)(1).
    \56\ The Exchange notes that Order I would receive the liquidity 
provide credit and Order G would be charged the liquidity taking 
fee, pursuant to Section E.1 of the Fee Schedule of the Exchange, 
even though Order I was initially received after Order G.
---------------------------------------------------------------------------

     Unrouted remainder of Order H would be released from LTAD 
at 10:00:00.001410 as the Matching System was processing the unrouted 
remainder of Order G when the unrouted remainder of Order H became 
releasable at 10:00:00.001370. Thus, Order H would be processed and 
given the Immediate Feedback received from the routed portion of Order 
H and the fact that the Immediate Feedback had not expired, the 
unrouted remainder of Order H would post to the CHX book at 
10:00:00.001460, due to system-processing delay. The result is that the 
CHX book would be as follows:

                            Fig 3f--CHX Book
------------------------------------------------------------------------
                    Buy                                 Sell
------------------------------------------------------------------------
Empty.....................................  Order H: 1000 at 9.99.
------------------------------------------------------------------------

    Example 4: Routing--Expired Feedback. Assume the same as Example 3, 
except that immediately prior to the unrouted portion of Order G being 
released, the Exchange received an updated quote from Away Market 
A1 displaying 1,000 shares at the $10.01.
    Under this Example 4, the Immediate Feedback derived from the 
immediately routed portion of Order G would expire and, upon release of 
the unrouted delayed portion of Order G, the Matching System would 
route the entire unrouted portion to satisfy the updated Protected Bid 
displayed by Away Market A1.
    Similarly, the Immediate Feedback derived from the immediately 
routed portion of Order H would also expire and, upon release of the 
unrouted delayed portion of Order H, the Matching System would route 
the entire unrouted portion to satisfy the updated Protected Bid 
displayed by Away Market A1.
    Example 5: MTP. Assume the same as Example 3, except that Order G 
and Order I originated from the same MTP Trading Group and Order G has 
an MTP Action of ``N.''
    Under this Example 5, pursuant to the current MTP rules, MTP would 
be triggered and the unrouted remainder of Order G would be cancelled, 
as the current ``N'' MTP Action requires the incoming order to be 
cancelled. However, pursuant to the proposed amended MTP rules, Order I 
would be cancelled, as the amended ``N'' MTP action requires the newer 
order to be cancelled, absent a price sliding event.
Operative Date
    In the event the proposed rule change is approved by the SEC, the 
proposed rule change shall be operative pursuant to notice by the 
Exchange to its Participants. Prior to the operative date, the Exchange 
will ensure that policies and procedures are in place to allow Exchange 
operations personnel to effectively monitor the operation of LTAD.
Appendix A: CHX ETF Analysis
    The purpose of the CHX ETF Analysis is to demonstrate that latency 
arbitrage activity \57\ in SPY at CHX (``SPY latency arbitrage 
activity'') has (1) reduced volume and displayed liquidity in SPY at 
CHX and (2) impaired liquidity provision in SPY marketwide. For the 
purpose of this CHX ETF Analysis, the following terms shall have the 
following meanings: \58\
---------------------------------------------------------------------------

    \57\ See supra note 3.
    \58\ Other capitalized terms utilized in the CHX ETF Analysis 
shall have the meanings set forth under Appendix B.
---------------------------------------------------------------------------

     After Period refers to February 2016 through July 2016.
     Analysis Period refers to August 2015 through July 2016.
     Before Period refers to August 2015 through December 2015.
     Control Average refers to the arithmetic average of a 
given metric for Control Securities.
     Control Securities refers to DIA, IWM, and QQQ.\59\
---------------------------------------------------------------------------

    \59\ Each of the Control Securities were selected for the 
following similarities to SPY in that each is: (1) Highly correlated 
in price movements with a well-known equity market index; (2) ETFs; 
(3) traded in CHX's Chicago data center; (4) actively traded in the 
NMS; and (5) Highly correlated with a futures contract traded 
electronically on the Globex trading platform.
---------------------------------------------------------------------------

     Entry Event refers to a trading day in January 2016 on 
which latency arbitrage activity in SPY at CHX was first observed.

[[Page 65449]]

     Entry Month refers to January 2016, the month in which 
latency arbitrage activity in SPY at CHX was first observed.
     Subject Securities refers to SPY and the Control 
Securities.
Entry of SPY Latency Arbitrage Activity
    During the After Period, the Exchange observed unusual messaging 
patterns in SPY whereby executions of large inbound Immediate Or Cancel 
(``IOC'') \60\ orders against resting orders in SPY were frequently 
followed by the receipt of late cancel messages for the executed 
resting orders very soon after the execution. This observation was 
corroborated by feedback from liquidity providing Participants that 
indicated that, unlike prior to the Entry Event, they were no longer 
able to reliably cancel or cancel/adjust resting orders on the CHX book 
in SPY in response to market changes after the Entry Event. The 
Exchange believes that each instance of the unusual messaging pattern 
is the end result of a race triggered by an away market event (e.g., 
change in market data from a futures market) where the liquidity taker 
is able to take a resting order at a stale price before the liquidity 
provider could adjust the resting order to accurately reflect the 
market.\61\ As such, the SPY latency arbitrage activity has had the 
following impact on volume and liquidity in SPY at CHX and away 
exchanges:
---------------------------------------------------------------------------

    \60\ See CHX Article 1, Rule 2(d)(4).
    \61\ See supra note 10.
---------------------------------------------------------------------------

Analysis 1: SPY Latency Arbitrage Activity Reduced CHX Market Share in 
SPY Relative to Total Volume in SPY and Disproportionately To Control 
Securities
    As shown under Figure 1, CHX Market Share in SPY as a percentage of 
Total Volume dropped by 90.1% from 5.73% in the Entry Month to 0.57% in 
July 2016, while CHX Market Share in the Control Average dropped by 
45.20% from 5.54% in the Entry Month to 3.03% in July 2016.\62\ As 
shown under Figure 2, changes in the average Total Volume during the 
Analysis Period for the Subject Securities were highly correlated. 
Thus, Figure 1 and Figure 2 show that despite the high correlation 
between SPY and each of the Control Securities during the Analysis 
Period, the CHX Market Share in SPY decreased disproportionately to 
Total Volume, which the Exchange submits is attributed to the SPY 
latency arbitrage activity.
---------------------------------------------------------------------------

    \62\ See infra Appendix B Calculation Set 1a.
    [GRAPHIC] [TIFF OMITTED] TN22SE16.001
    
    Figure 1. This figure illustrates the decrease in CHX Market Share 
as a percentage of Total Volume in the Subject Securities (Index: 
January 2016 = 100).\63\
---------------------------------------------------------------------------

    \63\ See infra Appendix B Calculation Sets 1a and 1b.

---------------------------------------------------------------------------

[[Page 65450]]

[GRAPHIC] [TIFF OMITTED] TN22SE16.002

    Figure 2. This figure illustrates the correlation in the Total 
Volume between SPY and the Control Average (Index: January 2016 = 100) 
during the Analysis Period.\64\ \65\
---------------------------------------------------------------------------

    \64\ The correlation coefficients ([rho]) over the twelve-month 
period were: [rho](SPY, DIA) = 0.9118, [rho](SPY, IWM) = 0.8996, 
[rho](SPY, QQQ) = 0.9392, [rho](SPY, Average) = 0.9493.
    \65\ See infra Appendix B Calculation Sets 2a and 2b.
---------------------------------------------------------------------------

Analysis 2: SPY Latency Arbitrage Activity Resulted in Less 
Aggressively Priced and Smaller Orders in SPY at CHX
    While the Exchange did not observe any discernable change on the 
NBBO spread in SPY during the After Period, the Exchange did observe a 
negative impact on the frequency at which CHX was at the NBBO in SPY 
and the frequency at which CHX displayed the largest quote at the NBBO 
in SPY during the After Period, while Control Securities experienced 
either smaller declines or no declines at all.\66\
---------------------------------------------------------------------------

    \66\ See infra Appendix B Calculation Sets 6 and 7.
---------------------------------------------------------------------------

    Specifically, the % of Time CHX Was At The NBB decreased from 23.8% 
in the Entry Month to 8.2% in July 2016; \67\ the % of Time CHX Was At 
The NBO decreased from 23.3% in the Entry Month to 5.8% in July 2016; 
\68\ and the % of Time CHX Was At The NBB and that CHX Was At The NBO 
decreased from 3.3% in the Entry Month to 0% in July 2016.\69\
---------------------------------------------------------------------------

    \67\ See infra Appendix B Calculation Set 6a.
    \68\ See infra Appendix B Calculation Set 6b.
    \69\ See infra Appendix B Calculation Set 6c.
---------------------------------------------------------------------------

    Moreover, the % of Time CHX Was At The NBB And Was The Largest Bid 
At That Price decreased from 20% in the Entry Month to 2.3% in July 
2016; \70\ the % of Time CHX Was At The NBO And Was The Largest Offer 
At That Price decreased from 20.7% in the Entry Month to 1.1% in July 
2016; \71\ and the % of Time CHX Was At The NBB And Was The Largest Bid 
At That Price and that CHX Was At The NBO And Was The Largest Offer At 
That Price decreased from 1.9% to 0%.\72\
---------------------------------------------------------------------------

    \70\ See infra Appendix B Calculation Set 7a.
    \71\ See infra Appendix B Calculation Set 7b.
    \72\ See infra Appendix B Calculation Set 7c.
---------------------------------------------------------------------------

    These calculation sets clearly show that SPY latency arbitrage 
activity resulted in less aggressively priced CHX displayed liquidity 
in SPY and smaller CHX displayed size at the NBBO, during the After 
Period. SPY latency arbitrage also negatively impacted the percentage 
of the time that CHX was at the NBBO and the percentage of the time CHX 
displayed the largest quote at the NBBO.
Analysis 3: Latency Arbitrage Activity at CHX Reduced CHX Size at The 
NBBO in SPY Relative to the Control Securities and NMS Size at The NBBO
    As shown under Figure 3, during the Before Period, the Time-
weighted Average CHX Size at The NBBO for SPY tended to follow changes 
to the Control Average, whereas from the Entry Month through July 2016, 
the Time-weighted Average CHX Size At The NBBO for SPY decreased by 
82.16% and the Time-weighted Average CHX Size At The NBBO for the 
Control Average increased by 64.38%.\73\ As shown under Figure 4, 
during the Before Period, the monthly changes in the Time-weighted 
Average CHX Size At The NBBO tended to follow similar changes to the 
Time-weighted Average NMS Size At The NBBO. However, during the After 
Period, the monthly changes in the Time-weighted Average CHX Size At 
The NBBO in SPY did not follow changes to the Time-weighted Average NMS 
Size At The NBBO in SPY. Moreover, during the After Period, CHX went 
from having a Two-Sided Market in SPY 100% of regular trading hours in 
the Entry Month to 74% of regular trading hours in July 2016.\74\
---------------------------------------------------------------------------

    \73\ See infra Appendix B Calculation Sets 3a and 3b.
    \74\ See infra Appendix B Calculation Set 5.
---------------------------------------------------------------------------

    Thus, Figure 3 and Figure 4 show that SPY latency arbitrage 
negatively impacted liquidity in SPY marketwide. Moreover, the data 
shows that the change in the risk/reward of providing liquidity in SPY 
at CHX which resulted from the introduction of the SPY latency 
arbitrage activity resulted in a significant reduction of liquidity in 
SPY provided by CHX, even during a period when significant incremental 
liquidity was being added in the Control Securities.

[[Page 65451]]

[GRAPHIC] [TIFF OMITTED] TN22SE16.003

    Figure 3. This figure illustrates the Time-weighted Average CHX 
Size At The NBBO in the Subject Securities (Indexed: January 2016 = 
100) during the Analysis Period.\75\
---------------------------------------------------------------------------

    \75\ See infra Appendix B Calculation Sets 3a and 3b.
    [GRAPHIC] [TIFF OMITTED] TN22SE16.004
    
    Figure 4. This figure illustrates the Time-weighted Average CHX 
Size At The NBBO in SPY versus Time-weighted Average NMS Size At The 
NBBO in SPY (Indexed: January 2016 = 100) during the Analysis 
Period.\76\
---------------------------------------------------------------------------

    \76\ See infra Appendix B Calculation Sets 3b and 4b.
---------------------------------------------------------------------------

Analysis 4: SPY Latency Arbitrage Activity Reduced Displayed Liquidity 
in SPY Marketwide
    Although the Time-weighted Average NMS Size At The NBBO in SPY 
increased by 22.83% during the After Period, the increase in SPY did 
not follow much greater increases in the Time-weighted Average NBBO 
Size in the Control Group, which increased by 128.82% during the After 
Period.\77\ Moreover, during the After Period, the Time-weighted 
Average CHX Size At The NBBO for SPY decreased by 90.61% \78\ and, as a 
% of total NMS Size At The NBBO in SPY, from 44.36% to

[[Page 65452]]

3.39%.\79\ These calculations suggest that the SPY latency arbitrage 
activity materially impacted displayed liquidity in SPY marketwide. The 
dramatic decrease in displayed liquidity in SPY at CHX during the After 
Period explains why the increase in Time-weighted Average NBBO Size in 
SPY lagged behind the increase in Time-weighted Average NBBO Size in 
the Control Securities. Had CHX Size At The NBBO remained at least 
constant during the After Period, NBBO Size in SPY would have been at 
least 32.7% higher in July 2016, as shown below: \80\
---------------------------------------------------------------------------

    \77\ See infra Appendix B Calculation Set 4a.
    \78\ See infra Appendix B Calculation Set 3a.
    \79\ See infra Appendix B Calculations Sets 3a and 4a.
    \80\ See infra Appendix B Calculation Set 4a.

----------------------------------------------------------------------------------------------------------------
                                                 NMS size at NBBO                       Change attribution
                                 -------------------------------------------------------------------------------
                                      Jan-16          Jul-16          Change            CHX           Others
----------------------------------------------------------------------------------------------------------------
SPY.............................           9,513          11,686           2,172          -3,824           5,996
DIA.............................           2,569           4,711           2,142           1,227             915
IWM.............................           5,222          10,026           4,804             536           4,268
QQQ.............................          14,100          35,354          21,253           3,900          17,353
Control Average.................           7,297          16,697           9,400           1,888           7,512
----------------------------------------------------------------------------------------------------------------

Conclusion
    Based on its observations of unusual messaging patterns in SPY, 
feedback from Participants and the analysis summarized above, the 
Exchange believes that the unusual messaging activity in SPY that was 
first observed in the Entry Month is attributed to SPY latency 
arbitrage activity. The market data shows that in response to the SPY 
latency arbitrage activity, CHX liquidity providers displayed smaller 
orders in SPY at less aggressive prices during the After Period 
relative to the Before Period and Entry Month. Moreover, in light of 
CHX's significant contribution to overall volume and liquidity in SPY 
during the Before Period and the Entry Month, diminished displayed 
liquidity at CHX has materially impaired displayed liquidity in SPY 
marketwide.
Appendix B: Calculation Sets
    The calculations sets below were prepared with microsecond-level 
trade and quote record. Trade records include the date, microsecond-
level timestamp, exchange, security symbol, price, and quantity of all 
trades reported to the consolidated tape. Quote records include the 
date, microsecond-level timestamp, exchange, security symbol, bid 
price, bid quantity, ask price, and ask quantity of all quotes reported 
to the consolidated tape. Only protected quotations are reported to the 
consolidated tape.
    The Analysis Period for the calculations begins on August 1, 2015 
and ends on July 31, 2016. Symbols SPY and three other Control 
Securities (i.e., DIA, IWM, and QQQ) were considered. Only trades and 
quotes that occurred on the national securities exchanges during the 
regular trading hours \81\ were considered. Certain types of non-
standard trades were excluded.\82\ Quotes with negative prices or 
quantities were excluded. Unless otherwise indicated, lengths of time 
when the market was locked or crossed were not considered.
---------------------------------------------------------------------------

    \81\ See 17 CFR 242.600(b)(64).
    \82\ Non-standard trades include derivatively priced trades, 
qualified contingent trades, opening trades, closing trades, and 
after hours trades.
---------------------------------------------------------------------------

    In the calculations below:
     Total Volume refers to the number of shares of the 
indicated symbol traded on the national securities exchanges on a given 
day, excluding certain types of non-standard trades. CHX Volume refers 
to the number of shares of the indicated symbol traded on CHX on a 
given day, excluding certain types of non-standard trades.
     CHX Market Share was calculated as CHX Volume divided by 
Total Volume on a given day, CHX Market Share = CHX Volume / Total 
Volume.
     CHX Had A Two-Sided Market refers to an indicator variable 
defined as true at any microsecond when there was at least one bid and 
at least one offer among all outstanding orders on CHX, and false 
otherwise. CHX Had A One-Sided Market refers to an indicator variable 
defined as true at any microsecond when there was at least one bid but 
no offers among all outstanding orders on CHX or when there was at 
least one offer but no bids among all outstanding orders on CHX, and 
false otherwise. CHX Had No Market refers to an indicator variable 
defined as true at any microsecond when there were no outstanding 
orders on CHX, and false otherwise.
     A bid was At The NBB at any microsecond when its price was 
equal to the National Best Bid. An offer was At The NBO at any 
microsecond when its price was equal to the National Best Offer.
     At any microsecond, the NMS Size At The National Best Bid 
(``NMS Size At The NBB'') refers to the quantity of shares in 
prevailing bids on the national securities exchanges priced at the 
National Best Bid and the NMS Size At The National Best Offer (``NMS 
Size At The NBO'') refers to the quantity of shares in prevailing 
offers on the national securities exchanges priced at the National Best 
Offer. NMS Size At The NBBO was calculated as the average of the 
National Best Bid Size and the National Best Offer Size at each 
microsecond, NMS Size At The NBBO = (NMS Size At The NBB + NMS Size At 
The NBO) / 2.
     CHX Was At The NBB refers to an indicator variable defined 
as true at any microsecond when the CHX Best Bid was at the National 
Best Bid, and false otherwise. CHX Was At The NBO refers to an 
indicator variable defined as true at any microsecond when the CHX Best 
Offer was at the National Best Offer, and false otherwise.
     At any microsecond, the CHX Size At The NBB (``CHX Size At 
The NBB'') refers to the CHX Best Bid Size if CHX was at the NBB and 
zero if CHX was not at the NBB. At any microsecond, the CHX Size At The 
NBO (``CHX Size At The NBO'') refers to the CHX Best Offer Size if CHX 
was at the NBO and zero if CHX was not at the NBO. CHX Size At The NBBO 
was calculated as the average of the CHX Size At The NBB and CHX Size 
At The NBO at each microsecond, CHX Size At The NBBO = (CHX Size At The 
NBB + CHX Size At The NBO) / 2.
     CHX Was At The NBB And Was The Largest Bid At That Price 
refers to an indicator variable defined as true at any microsecond when 
CHX was at the National Best Bid and the CHX Best Bid Size was greater 
than or equal to the largest quantity of shares in prevailing bids on 
any one national securities exchange other than CHX, and false 
otherwise. CHX Was At The NBO And Was The Largest Offer At That Price 
refers to an indicator variable defined as true at any microsecond when 
CHX was at the National Best Offer and the CHX Best Offer Size was 
greater than or equal to the largest quantity of shares in prevailing 
offers on any one national securities exchange other than CHX, and 
false otherwise.

[[Page 65453]]

    For the calculations in the table below:
     Monthly average values are shown. Monthly 
average values were calculated as the average of daily values for each 
day in a month. Daily values were calculated as time-weighted averages 
or as percentages of time in the trading day, as indicated in the 
table. Time-weighted average values were calculated as daily average of 
the specified quantity, market share, or spread value weighted by time 
(in microseconds). % of time values were calculated as the length of 
time (in microseconds) for which the specified indicator variable was 
true divided by the length of time in that trading day, excluding 
lengths of time during which the market was locked or crossed or 
otherwise could not be calculated (e.g., at the start of the trading 
day).

----------------------------------------------------------------------------------------------------------------
                                                                              Symbol
                                                ----------------------------------------------------------------
                                                     SPY          DIA          IWM          QQQ        Control
    No.        Calculation          Month       ----------------------------------------------------   average
                                                                                                    ------------
                                                     [1]          [2]          [3]          [4]       ([2]:[4])
----------------------------------------------------------------------------------------------------------------
[1a]......  CHX Market Share  Aug 2015.........        4.32%        3.07%        5.51%        3.40%        3.99%
             (% of Total
             Volume).
                              Sep 2015.........        6.07%        2.61%        3.82%        3.46%        3.30%
                              Oct 2015.........        4.08%        5.95%        2.58%        4.42%        4.32%
                              Nov 2015.........        4.49%        8.58%        3.14%        5.13%        5.62%
                              Dec 2015.........        4.85%        4.89%        2.53%        4.49%        3.97%
                              Jan 2016.........        5.73%        9.13%        3.14%        4.35%        5.54%
                              Feb 2016.........        4.78%        9.13%        3.32%        4.41%        5.62%
                              Mar 2016.........        2.80%        7.54%        2.38%        3.57%        4.50%
                              Apr 2016.........        2.28%        4.41%        2.01%        2.69%        3.04%
                              May 2016.........        1.10%        3.53%        2.21%        1.93%        2.55%
                              Jun 2016.........        0.90%        5.17%        1.74%        3.00%        3.30%
                              Jul 2016.........        0.57%        6.11%        1.22%        1.77%        3.03%
[1b]......  CHX Market Share  Aug 2015.........           75           34          176           78           72
             (% of Total      Sep 2015.........          106           29          122           80           60
             Volume).
            Index: January
             2016 = 100.
                              Oct 2015.........           71           65           82          102           78
                              Nov 2015.........           78           94          100          118          101
                              Dec 2015.........           85           54           81          103           72
                              Jan 2016.........          100          100          100          100          100
                              Feb 2016.........           83          100          106          102          102
                              Mar 2016.........           49           83           76           82           81
                              Apr 2016.........           40           48           64           62           55
                              May 2016.........           19           39           70           44           46
                              Jun 2016.........           16           57           55           69           60
                              Jul 2016.........           10           67           39           41           55
[2a]......  Average Total     Aug 2015.........  130,150,083    6,153,725   26,846,599   33,963,873   23,568,046
             Volume.
                              Sep 2015.........   94,627,144    6,552,649   21,381,524   28,452,481   19,947,099
                              Oct 2015.........   75,881,581    4,461,519   22,420,310   22,701,556   14,268,977
                              Nov 2015.........   63,307,314    3,673,677   16,624,141   17,531,483   10,308,999
                              Dec 2015.........   87,011,822    4,969,853   23,287,782   24,474,150   16,211,695
                              Jan 2016.........  127,469,871    8,301,912   35,204,822   39,029,308   21,425,674
                              Feb 2016.........   97,911,733    6,121,299   27,668,000   35,547,824   18,060,375
                              Mar 2016.........   63,333,000    2,521,807   20,709,893   17,600,599    9,724,974
                              Apr 2016.........   53,023,531    2,337,084   15,556,074   14,984,599    8,991,216
                              May 2016.........   51,578,634    2,016,095   17,899,288   14,856,962    9,822,504
                              Jun 2016.........   78,385,026    2,740,421   20,938,721   16,963,513   10,240,678
                              Jul 2016.........   49,783,615    2,130,330   14,122,275   11,973,239    5,657,111
[2b]......  Average Total     Aug 2015.........          102           74           76           87          110
             Volume.          Sep 2015.........           74           79           61           73           93
            Index: Jan 2016
             = 100.
                              Oct 2015.........           60           54           64           58           67
                              Nov 2015.........           50           44           47           45           48
                              Dec 2015.........           68           60           66           63           76
                              Jan 2016.........          100          100          100          100          100
                              Feb 2016.........           77           74           79           91           84
                              Mar 2016.........           50           30           59           45           45
                              Apr 2016.........           42           28           44           38           42
                              May 2016.........           40           24           51           38           46
                              Jun 2016.........           61           33           59           43           48
                              Jul 2016.........           39           26           40           31           26
[3a]......  Time-weighted     Aug 2015.........     7,740.13       753.47     2,294.04     3,666.82     2,238.11
             Average CHX      Sep 2015.........     6,217.48       682.18     2,157.29     4,177.88     2,339.12
             Size At The
             NBBO.
                              Oct 2015.........     7,816.38     1,308.53     2,052.68     6,130.87     3,164.03
                              Nov 2015.........     8,983.84     2,439.37     2,158.33     7,182.16     3,926.62
                              Dec 2015.........     5,776.73     1,152.21     1,517.59     4,347.08     2,338.96
                              Jan 2016.........     4,220.05     1,830.97     1,726.35     4,341.83     2,633.05
                              Feb 2016.........     2,642.32     1,829.95     2,004.50     4,523.73     2,786.06
                              Mar 2016.........     1,611.90     2,347.82     2,077.08     5,987.78     3,470.89
                              Apr 2016.........     1,415.95     1,481.35     2,314.10     6,196.84     3,330.76
                              May 2016.........       485.23     1,469.69     2,374.66     7,423.33     3,755.89
                              Jun 2016.........       565.73     1,772.03     2,188.41     7,994.73     3,985.06
                              Jul 2016.........       396.37     3,057.61     2,262.70     8,241.77     4,520.69

[[Page 65454]]

 
[3b]......  Time-weighted     Aug 2015.........          183           41          133           84           85
             Average CHX      Sep 2015.........          147           37          125           96           89
             Size At The      Oct 2015.........          185           71          119          141          120
             NBBO.
            Index: Jan 2016
             = 100.
                              Nov 2015.........          213          133          125          165          149
                              Dec 2015.........          137           63           88          100           89
                              Jan 2016.........          100          100          100          100          100
                              Feb 2016.........           63          100          116          104          106
                              Mar 2016.........           38          128          120          138          132
                              Apr 2016.........           34           81          134          143          126
                              May 2016.........           11           80          138          171          143
                              Jun 2016.........           13           97          127          184          151
                              Jul 2016.........            9          167          131          190          172
[4a]......  Time-weighted     Aug 2015.........    19,257.66     2,609.35     6,511.42    18,471.79     9,197.52
             Average NMS      Sep 2015.........    11,919.38     1,679.93     6,540.46    14,223.92     7,481.44
             Size At The
             NBBO.
                              Oct 2015.........    18,309.27     2,468.56     6,972.46    19,848.75     9,763.26
                              Nov 2015.........    19,257.58     3,930.75     6,963.92    23,442.48    11,445.72
                              Dec 2015.........    13,230.66     2,204.20     5,812.28    17,106.74     8,374.40
                              Jan 2016.........     9,513.33     2,569.26     5,221.94    14,100.46     7,297.22
                              Feb 2016.........     7,417.60     2,489.46     6,340.40    13,869.32     7,566.40
                              Mar 2016.........     8,638.39     3,703.26     8,521.28    20,316.43    10,846.99
                              Apr 2016.........     9,876.59     3,070.53     9,422.71    23,246.57    11,913.27
                              May 2016.........     9,398.26     3,144.93    10,295.88    28,354.88    13,931.90
                              Jun 2016.........     9,313.10     3,107.54     9,597.43    28,288.57    13,664.51
                              Jul 2016.........    11,685.53     4,711.37    10,026.35    35,353.64    16,697.12
[4b]......  Time-weighted     Aug 2015.........          202          102          125          131          126
             Average NMS      Sep 2015.........          125           65          125          101          103
             Size At The      Oct 2015.........          192           96          134          141          134
             NBBO.
            Index: Jan 2016
             = 100.
                              Nov 2015.........          202          153          133          166          157
                              Dec 2015.........          139           86          111          121          115
                              Jan 2016.........          100          100          100          100          100
                              Feb 2016.........           78           97          121           98          104
                              Mar 2016.........           91          144          163          144          149
                              Apr 2016.........          104          120          180          165          163
                              May 2016.........           99          122          197          201          191
                              Jun 2016.........           98          121          184          201          187
                              Jul 2016.........          123          183          192          251          229
[5a]......  % of Time CHX     Aug 2015.........        99.8%        99.6%        99.7%        99.6%        99.7%
             Had A Two-Sided
             Market.
                              Sep 2015.........        99.9%        99.9%        99.9%        99.9%        99.9%
                              Oct 2015.........       100.0%        99.9%        99.9%       100.0%        99.9%
                              Nov 2015.........        99.9%        99.9%        99.5%        99.8%        99.7%
                              Dec 2015.........        98.6%        98.3%        98.6%        98.6%        98.5%
                              Jan 2016.........       100.0%        99.9%        99.9%       100.0%        99.9%
                              Feb 2016.........        99.9%       100.0%       100.0%       100.0%       100.0%
                              Mar 2016.........        99.8%       100.0%       100.0%       100.0%       100.0%
                              Apr 2016.........        99.3%        99.9%       100.0%        99.8%        99.9%
                              May 2016.........        85.2%        99.9%       100.0%       100.0%       100.0%
                              Jun 2016.........        73.2%        99.9%       100.0%       100.0%       100.0%
                              Jul 2016.........        74.0%        99.9%       100.0%       100.0%       100.0%
[5b]......  % of Time CHX     Aug 2015.........         0.1%         0.1%         0.0%         0.2%         0.1%
             Had A One-Sided
             Market.
                              Sep 2015.........         0.0%         0.0%         0.0%         0.0%         0.0%
                              Oct 2015.........         0.0%         0.0%         0.0%         0.0%         0.0%
                              Nov 2015.........         0.0%         0.0%         0.0%         0.2%         0.1%
                              Dec 2015.........         0.0%         0.3%         0.0%         0.0%         0.1%
                              Jan 2016.........         0.0%         0.1%         0.0%         0.0%         0.0%
                              Feb 2016.........         0.0%         0.0%         0.0%         0.0%         0.0%
                              Mar 2016.........         0.2%         0.0%         0.0%         0.0%         0.0%
                              Apr 2016.........         0.2%         0.0%         0.0%         0.0%         0.0%
                              May 2016.........         3.0%         0.0%         0.0%         0.0%         0.0%
                              Jun 2016.........         6.1%         0.0%         0.0%         0.0%         0.0%
                              Jul 2016.........         1.8%         0.0%         0.0%         0.0%         0.0%
[5c]......  % of Time CHX     Aug 2015.........         0.1%         0.3%         0.3%         0.1%         0.2%
             Had No Market.
                              Sep 2015.........         0.0%         0.1%         0.1%         0.0%         0.1%
                              Oct 2015.........         0.0%         0.1%         0.1%         0.0%         0.1%
                              Nov 2015.........         0.1%         0.1%         0.4%         0.0%         0.2%
                              Dec 2015.........         1.4%         1.4%         1.4%         1.4%         1.4%
                              Jan 2016.........         0.0%         0.0%         0.0%         0.0%         0.0%
                              Feb 2016.........         0.1%         0.0%         0.0%         0.0%         0.0%
                              Mar 2016.........         0.0%         0.0%         0.0%         0.0%         0.0%
                              Apr 2016.........         0.5%         0.1%         0.0%         0.2%         0.1%
                              May 2016.........        11.8%         0.1%         0.0%         0.0%         0.0%

[[Page 65455]]

 
                              Jun 2016.........        20.7%         0.1%         0.0%         0.0%         0.0%
                              Jul 2016.........        24.2%         0.0%         0.0%         0.0%         0.0%
[6a]......  % of Time CHX     Aug 2015.........        16.5%        32.7%        46.9%        58.0%        45.9%
             Was At The NBB.
                              Sep 2015.........        24.0%        36.4%        44.7%        67.6%        49.6%
                              Oct 2015.........        30.8%        45.8%        44.3%        74.9%        55.0%
                              Nov 2015.........        24.5%        50.3%        54.0%        79.6%        61.3%
                              Dec 2015.........        29.2%        34.1%        38.3%        71.3%        47.9%
                              Jan 2016.........        23.8%        46.0%        40.2%        70.4%        52.2%
                              Feb 2016.........        15.5%        53.9%        33.7%        65.5%        51.0%
                              Mar 2016.........        18.5%        58.4%        35.6%        66.8%        53.6%
                              Apr 2016.........        18.7%        46.8%        35.9%        60.5%        47.7%
                              May 2016.........         7.0%        44.8%        53.5%        68.5%        55.6%
                              Jun 2016.........         5.4%        47.1%        44.2%        72.8%        54.7%
                              Jul 2016.........         8.2%        45.9%        40.8%        74.1%        53.6%
[6b]......  % of Time CHX     Aug 2015.........        27.9%        39.8%        57.0%        65.6%        54.1%
             Was At The NBO.
                              Sep 2015.........        29.7%        36.0%        41.8%        66.7%        48.2%
                              Oct 2015.........        20.9%        41.4%        42.7%        74.0%        52.7%
                              Nov 2015.........        28.7%        39.3%        52.9%        78.2%        56.8%
                              Dec 2015.........        27.1%        35.5%        42.4%        70.0%        49.3%
                              Jan 2016.........        23.3%        52.3%        48.8%        70.4%        57.2%
                              Feb 2016.........        23.2%        55.5%        46.3%        69.1%        57.0%
                              Mar 2016.........        19.0%        58.5%        44.4%        70.0%        57.7%
                              Apr 2016.........        14.0%        44.0%        36.4%        65.8%        48.7%
                              May 2016.........        12.4%        40.4%        49.3%        64.2%        51.3%
                              Jun 2016.........        11.0%        47.3%        48.4%        74.6%        56.8%
                              Jul 2016.........         5.8%        46.0%        34.0%        69.4%        49.8%
[6c]......  % of Time CHX     Aug 2015.........         1.0%         8.2%        19.7%        32.5%        20.2%
             Was At The NBB   Sep 2015.........         2.0%        10.0%         9.2%        37.1%        18.8%
             and that CHX
             Was At The NBO.
                              Oct 2015.........         3.0%        14.4%        10.2%        49.8%        24.8%
                              Nov 2015.........         6.0%        14.2%        17.9%        58.1%        30.1%
                              Dec 2015.........         4.4%         9.3%        12.5%        44.8%        22.2%
                              Jan 2016.........         3.3%        19.2%         7.8%        41.8%        22.9%
                              Feb 2016.........         1.0%        24.5%         4.8%        35.4%        21.5%
                              Mar 2016.........         0.5%        29.6%         4.6%        38.0%        24.1%
                              Apr 2016.........         0.2%        15.7%         2.2%        29.9%        15.9%
                              May 2016.........         0.0%        13.5%        17.5%        34.6%        21.9%
                              Jun 2016.........         0.0%        17.0%        12.2%        48.5%        25.9%
                              Jul 2016.........         0.0%        12.6%         4.0%        44.1%        20.3%
[7a]......  % of Time CHX     Aug 2015.........        13.6%        26.2%        37.1%        26.6%        29.9%
             Was At The NBB   Sep 2015.........        21.5%        34.0%        40.0%        47.6%        40.6%
             And Was The
             Largest Bid At
             That Price.
                              Oct 2015.........        24.9%        43.8%        36.2%        57.4%        45.8%
                              Nov 2015.........        18.8%        47.9%        39.4%        55.9%        47.7%
                              Dec 2015.........        25.1%        31.7%        27.7%        39.1%        32.8%
                              Jan 2016.........        20.0%        43.6%        32.0%        48.1%        41.2%
                              Feb 2016.........        11.2%        52.7%        28.5%        45.5%        42.2%
                              Mar 2016.........        11.9%        55.7%        28.3%        44.8%        42.9%
                              Apr 2016.........        13.0%        42.2%        31.6%        43.6%        39.1%
                              May 2016.........         1.7%        39.8%        37.9%        50.2%        42.6%
                              Jun 2016.........         2.0%        43.7%        32.2%        48.3%        41.4%
                              Jul 2016.........         2.3%        43.2%        31.7%        48.0%        41.0%
[7b]......  % of Time CHX     Aug 2015.........        24.3%        34.4%        51.2%        39.8%        41.8%
             Was At The NBO   Sep 2015.........        27.0%        33.8%        37.8%        46.7%        39.4%
             And Was The
             Largest Offer
             At That Price.
                              Oct 2015.........        16.0%        38.1%        31.3%        44.0%        37.8%
                              Nov 2015.........        22.6%        36.8%        35.1%        53.4%        41.8%
                              Dec 2015.........        23.2%        32.7%        30.6%        36.8%        33.4%
                              Jan 2016.........        20.7%        51.1%        41.3%        50.7%        47.7%
                              Feb 2016.........        18.5%        54.7%        40.8%        49.4%        48.3%
                              Mar 2016.........        12.9%        55.2%        35.3%        51.2%        47.2%
                              Apr 2016.........         8.1%        38.6%        30.8%        45.9%        38.4%
                              May 2016.........         3.8%        36.7%        29.8%        45.2%        37.2%
                              Jun 2016.........         4.6%        44.6%        31.4%        51.8%        42.6%
                              Jul 2016.........         1.1%        42.5%        27.0%        31.0%        33.5%
[7c]......  % of Time CHX     Aug 2015.........         0.2%         5.3%        12.8%         7.1%         8.4%
             Was At The NBB   Sep 2015.........         1.1%         8.5%         7.3%        16.7%        10.9%
             And Was The      Oct 2015.........         0.9%        12.3%         5.3%        17.7%        11.8%
             Largest Bid At   Nov 2015.........         2.3%        12.6%         7.0%        23.0%        14.2%
             That Price and
             that CHX Was At
             The NBO And Was
             The Largest
             Offer At That
             Price.
                              Dec 2015.........         2.9%         8.1%         6.4%        13.7%         9.4%
                              Jan 2016.........         1.9%        17.3%         4.3%        18.5%        13.4%
                              Feb 2016.........         0.3%        23.3%         2.8%        13.9%        13.3%
                              Mar 2016.........         0.1%        26.0%         2.6%        14.0%        14.2%

[[Page 65456]]

 
                              Apr 2016.........         0.0%        10.9%         1.5%        14.0%         8.8%
                              May 2016.........         0.0%        10.4%         8.0%        15.6%        11.3%
                              Jun 2016.........         0.0%        14.3%         4.8%        18.6%        12.5%
                              Jul 2016.........         0.0%        10.7%         2.8%        10.8%         8.1%
----------------------------------------------------------------------------------------------------------------

Appendix C: Impact of LTAD on Liquidity Takers
    The purpose of this analysis is to show that implementation of LTAD 
would not materially impact the ability of a random market participant 
not engaged in a latency arbitrage strategy to take displayed liquidity 
at CHX. This analysis assumes that LTAD would not materially change 
order sending behavior of Participants.
    For the period of May 2016 through July 2016,\83\ the Exchange 
observed the following with regards to SPY:
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    \83\ For the months prior to May 2016 during the Analysis 
Period, the Exchange did not maintain TLTC data. A limitation of 
this data is that CHX Market Share and displayed liquidity in SPY 
and, by extension, order sending activity had all diminished 
considerably by May 2016. See supra Appendix B Calculation Set 1.
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     There were a total of 18,316 orders at least partially 
executed.
     During the same period, the Exchange received 1,278 cancel 
messages to cancel resting orders after the resting order had been 
fully executed (``too-late-to-cancel'' or ``TLTC'').
     Of the 1,278 TLTCs, 412 TLTCs (32.24%) were received 
sooner than or exactly 350 microseconds after the execution 
(``TLTC<= 350''), whereas 866 (67.76%) were received later 
than 350 microseconds after the execution (``TLTC> 350'').
     Of the 412 TLTC<= 350, 392 (95.15%) executions 
were attributed to SPY latency arbitrage activity while the remaining 
20 (4.85%) executions were not.
     Of the 866 TLTC> 350, 780 (90.07%) executions 
were attributed to SPY latency arbitrage activity while the remaining 
86 (9.93%) executions were not.\84\
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    \84\ See supra note 4.
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    Thus, if LTAD had been in effect for the period of May 2016 through 
July 2016, LTAD (1) would have prevented up to 412 orders, virtually 
all of which the Exchange believes were submitted as part of SPY 
latency arbitrage activity, from being executed during the 350 
microsecond Fixed LTAD Period and (2) would have had a negative impact 
on only 20 liquidity taking orders not attributed to SPY latency 
arbitrage activity. These 20 orders comprised 0.11% of the 18,316 
orders executed during the period. That is, during the measurement 
period of 63 trading days, LTAD would have had an adverse effect on 
approximately one order every three trading days. Thus, LTAD can make a 
significant contribution to leveling the playing field between 
liquidity providers and latency arbitrageurs with minimal adverse 
effect on other liquidity taking orders.
2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6(b) of the Act in general,\85\ and furthers the 
objectives of Section 6(b)(5) in particular,\86\ in that it is designed 
to promote just and equitable principles of trade, to foster 
cooperation and coordination with persons engaged in facilitating 
transactions in securities, to remove impediments and perfect the 
mechanisms of a free and open market, and, in general, to protect 
investors and the public interest; and is not designed to permit unfair 
discrimination between customers, issuers, brokers, or dealers.
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    \85\ 15 U.S.C. 78f(b).
    \86\ 15 U.S.C. 78f(b)(5).
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    Specifically, the Exchange believes that the proposed rule change 
would remove impediments and perfect the mechanisms of a free and open 
market and, in general, protect investors and the public interest by 
enhancing displayed liquidity and price discovery for NMS securities by 
minimizing the effectiveness of latency arbitrage strategies that 
diminish quality and quantity of liquidity. As shown under the CHX ETF 
Analysis, latency arbitrage lessens competition among orders by 
dissuading liquidity providers from displaying large and aggressively 
priced orders, which in turn impairs market efficiency.\87\ The 
Commission has recognized the crucial role that displayed limit orders 
play in the price discovery process.\88\ Thus, the Exchange believes 
that optimizing liquidity provision on the Exchange will enhance price 
discovery for NMS securities and, thereby, enhance market efficiency. 
To this end, LTAD is designed to promote displayed liquidity on the 
Exchange by giving liquidity providers a small amount of additional 
time to cancel or adjust orders on the CHX book to comport to the most 
recent market data before latency arbitrageurs could take such orders 
at potentially ``stale'' prices. LTAD is designed to achieve these 
goals without adversely affecting the ability of virtually all market 
participants, other than latency arbitrageurs, to access liquidity at 
CHX.\89\ Thus, the Exchange believes that LTAD will encourage liquidity 
providers to resume posting large aggressively priced orders on the CHX 
book, which was their practice prior to the beginning of the SPY 
latency arbitrage activity in January 2016, which will enhance 
liquidity and optimize price discovery in furtherance of the objectives 
of Act and in a manner consistent with Regulation NMS, as described 
below.
---------------------------------------------------------------------------

    \87\ See Exchange Act Release No. 51808 (June 9, 2005), 70 FR 
37496 at 37499 (June 29, 2005) (``Regulation NMS Adopting 
Release''), which provides, in pertinent part: ``To the extent that 
competition among orders is lessened, the quality of price discovery 
for all sizes of orders can be compromised. Impaired price discovery 
could cause market prices to deviate from fundamental values, reduce 
market depth and liquidity, and create excessive short-term 
volatility that is harmful to long-term investors and listed 
companies. More broadly, when market prices do not reflect 
fundamental values, resources will be misallocated within the 
economy and economic efficiency--as well as market efficiency--will 
be impaired.''
    \88\ See Regulation NMS Adopting Release, id, at 37526.
    \89\ See supra note 19; see also supra Appendix C.
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    The Exchange also believes that the proposed amendments to the MTP 
order modifier would remove impediments and perfect the mechanisms of a 
free and open market and, in general, protect investors and the public 
interest, in that they are designed to avoid certain unintended 
consequences of LTAD on the MTP functionality. Specifically, since an 
order would be assigned a sequence number prior to being evaluated 
pursuant to LTAD,\90\ LTAD may result in a newer undelayed order being 
posted to the CHX book before an older delayed order, which would not 
otherwise occur today. Under this

[[Page 65457]]

scenario and assuming that the contra-side orders trigger MTP and the 
incoming order is marked ``N,'' the current MTP rules would require the 
incoming older order to be cancelled, whereas the amended MTP handling 
would require the resting newer order to be cancelled subject to the 
exception for CHX Only orders described under amended Article 1, Rule 
2(b)(3)(F)(iii)(a) and (b). Thus, the Exchange believes that the 
amended MTP functionality better contemplates LTAD and preserves 
expected results.
---------------------------------------------------------------------------

    \90\ See supra note 7.
---------------------------------------------------------------------------

    Moreover, the Exchange submits that the proposed rules for LTAD are 
not designed to permit unfair discrimination, and would not impose any 
unnecessary or inappropriate burden on competition. Rather, by 
neutralizing speed advantages utilized by latency arbitrageurs, LTAD is 
designed to ensure that liquidity providers resume achieving their 
goals with respect to their liquidity provision strategies on CHX that, 
prior to January 2016, resulted in valuable liquidity in securities 
such as SPY being provided to the marketplace.\91\ \92\ In addition, 
LTAD would facilitate the achievement of such goals while having a de 
minimis impact on random liquidity takers not engaged in latency 
arbitrage activities.\93\
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    \91\ See supra note 11; see also supra Appendix A.
    \92\ Since the Entry Event, the Exchange has observed latency 
arbitrage activity in other S&P-correlated securities traded on CHX, 
which has also negatively impacted displayed liquidity in those 
securities.
    \93\ See supra note 19; see also supra Appendix C.
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    In finding that the rules pertaining to the IEX Delay did not 
permit unfair discrimination, and would not impose any unnecessary or 
inappropriate burden on competition, the Commission recognized that 
displayed limit orders or non-pegged non-displayed limit orders, the 
types of liquidity LTAD is designed to protect, would not benefit from 
the symmetric IEX Delay \94\ because the purpose of such limit orders 
is to post or execute consistent with their fixed limit price, as 
opposed to being repriced by an exchange based on changes to the 
NBBO.\95\ When also considering that displayed limit orders and non-
pegged non-displayed limit orders -1- are as vulnerable to latency 
arbitrage attacks as pegged orders \96\ and -2- could only be 
effectively adjusted by the liquidity provider itself in response to 
market changes if such orders are provided as part of a broader 
liquidity provision strategy that utilizes proprietary algorithms to 
price and size such limit orders,\97\ it logically flows that the best 
way to protect such valuable displayed liquidity \98\ is through an 
asymmetric delay, such as LTAD, that empowers liquidity providers to 
more efficiently execute their liquidity provision strategies that 
result in valuable displayed liquidity being provided to the 
market.\99\ Thus, given the importance of this displayed liquidity and 
the ineffectiveness of symmetric delays in protecting limit orders from 
latency arbitrage, the Exchange believes that LTAD is narrowly-tailored 
to address latency arbitrage as applied to limit orders and, thus, any 
discrimination between liquidity providers and liquidity takers is 
justified and consistent with the requirements of the Act.\100\ 
Further, LTAD will be applied to all Participants, thus all 
Participants that provide liquidity in securities subject to LTAD \101\ 
will be able to benefit from the LTAD.
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    \94\ See IEX Approval Order, supra note 16, at 41157.
    \95\ See id.
    \96\ See supra note 3.
    \97\ See supra note 10.
    \98\ See supra Appendix A.
    \99\ See supra notes 11 and 12.
    \100\ The Exchange further notes that discrimination between 
liquidity providers and liquidity takers, in furtherance of the 
objectives of the Act, is not without substantial precedence in the 
NMS. The Commission has previously approved various initiatives that 
discriminate between liquidity providers and liquidity takers. For 
example, many national securities exchanges, including CHX, utilize 
the ``maker/taker'' fee model, which discriminates between liquidity 
providers and takers for the purpose of incentivizing market 
participants to provide liquidity to, and/or take liquidity from, 
the exchange, depending on the exchange's specific implementation. 
See e.g., Bats BYX Fee Schedule; see also Section E.1 of the CHX Fee 
Schedule. Similarly, the CHX offers a Market Data Revenue Sharing 
program, whereby only certain liquidity providers could receive a 
market data revenue rebate in proportion to the quality of liquidity 
provided. See Section P.1 of the CHX Fee Schedule. In fact, the IEX 
Delay discriminates between liquidity providers with resting pegged 
orders and liquidity takers, thereby necessarily discriminating 
between liquidity providers that utilize pegged orders and those 
that do not utilize pegged orders.
    \101\ See supra note 37.
---------------------------------------------------------------------------

    For similar reasons, the Exchange also believes that the proposed 
rule change is consistent with Regulation NMS as LTAD would constitute 
a de minimis intentional access delay and is thereby consistent with 
the requirements of Rule 600(b)(3) of Regulation NMS.\102\ Moreover, 
the Exchange further believes that LTAD is consistent with Rule 611 
\103\ and Rule 610(d) of Regulation NMS.\104\
---------------------------------------------------------------------------

    \102\ See 17 CFR 242.600(b)(3).
    \103\ See 17 CFR 242.611.
    \104\ See 17 CFR 242.610(d).
---------------------------------------------------------------------------

    Specifically, the Exchange believes that the proposed rule change 
is consistent with the ``immedia[cy]'' requirement of Rule 600(b)(3) as 
LTAD is a de minimis intentional access delay and thereby compatible 
with the Exchange having an ``automated quotation'' under Rule 
600(b)(3) and thus a ``protected quotation'' under Rule 611.\105\ Given 
that LTAD would enhance liquidity and optimize price discovery in NMS 
securities, would apply to all Participants and would not unfairly 
discriminate among Participants as it is narrowly tailored to minimize 
the effectiveness of latency arbitrage strategies with respect to limit 
orders, all in furtherance of the objectives of Section 6(b)(5) of the 
Act, as discussed above, the Exchange believes that LTAD would not 
impair fair and efficient access to the Exchange's protected 
quotation.\106\
---------------------------------------------------------------------------

    \105\ See Final Interpretation, supra note 9, at 40792.
    \106\ See id.
---------------------------------------------------------------------------

    Moreover, the Exchange believes that LTAD is consistent with the 
requirements of Rule 611.\107\ As described above,\108\ a portion of a 
Routable Order may be immediately routed away to execute against away 
protected quotations, with the unrouted remainder being delayed before 
being permitted to execute against an order resting on the CHX book at 
a price inferior to the away protected quotations by relying on the 
proposed Immediate Feedback derived from the immediate routed portion 
to ignore the away protected quotation. Given that LTAD is de minimis 
in the context of Rule 600(b)(3), it logically flows that LTAD should 
also be considered de minimis for the purposes of the ``simultaneously 
routed'' Intermarket Sweep Order (``ISO'') requirement under Rule 
611(b)(6). Thus, the Exchange submits that a delay caused by LTAD 
between the routing of one or more ISOs to satisfy better priced 
protected quotation(s) and the delayed execution of a related order 
through such protected quotation(s) is consistent with the requirements 
of Rule 611(b)(6).
---------------------------------------------------------------------------

    \107\ 17 CFR 242.611.
    \108\ See supra Example 3.
---------------------------------------------------------------------------

    Similarly, a portion of a Routable Order may be immediately routed 
away to execute against away protected quotations with the unrouted 
remainder being delayed before posting to the CHX book at a price that 
crosses such away protected quotations. This could result if the 
resting order on the CHX book that resulted in the unrouted remainder 
being delayed was cancelled before the unrouted remainder were released 
from LTAD. Under this scenario, given that LTAD is de minimis in the 
context of Rule 600(b)(3), it logically flows that the de minimis delay 
caused by LTAD

[[Page 65458]]

between the routing of one or more ISOs to satisfy away protected 
quotations and the actual display of the related order at a price that 
crosses such away protected quotations is permissible and consistent 
with the requirements of Rule 610(d).\109\
---------------------------------------------------------------------------

    \109\ See ``Division of Trading and Markets: Responses to 
Frequency Asked Questions Concerning Rule 611 and Rule 610 of 
Regulation NMS.'' U.S. Securities and Exchange Commission, 4 April 
2008. Web. 20 June 2016 https://www.sec.gov/divisions/marketreg/nmsfaq610-11.htm (``Question 5.02''); see also CHX Article 20, Rule 
6(c)(3).
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B. Self-Regulatory Organization's Statement on Burden on Competition
    The Exchange does not believe that the proposed rule change will 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act. To the contrary, the 
Exchange believes that any burden on competition is necessary and 
appropriate in furtherance of the purposes of Section 6(b)(5) of the 
Act because LTAD is functionality that seeks to enhance liquidity and 
optimize price discovery by deemphasizing speed as a key to trading 
success in order to further serve the interests of investors and 
thereby removes impediments and perfects the mechanisms of a free and 
open market.\110\
---------------------------------------------------------------------------

    \110\ See supra note 15.
---------------------------------------------------------------------------

    The Exchange further notes that market participants will continue 
to be able to obtain CHX book data via the SIPs or through the 
Exchange's proprietary book feed, the CHX Book Feed,\111\ without delay 
as the Exchange does not propose to delay any outbound messages or 
market data. As such, the Exchange submits that any burden on 
competition, while necessary and appropriate in furtherance of the 
purposes of that Act, has been minimized.
---------------------------------------------------------------------------

    \111\ See CHX Article 4, Rule 1.
---------------------------------------------------------------------------

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve or disapprove the proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-CHX-2016-16 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-CHX-2016-16. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (https://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filing will also be available 
for inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-CHX-2016-16 and should be 
submitted on or before October 13, 2016.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\112\
---------------------------------------------------------------------------

    \112\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Robert W. Errett,
Deputy Secretary.
[FR Doc. 2016-22790 Filed 9-21-16; 8:45 am]
 BILLING CODE 8011-01-P