What Is an Alternative Trading System (ATS)?

What Is an Alternative Trading System (ATS)?

Let me explain what an alternative trading system, or ATS, really is. It's a trading venue that's regulated more loosely than a traditional exchange. You see, ATS platforms are commonly used to match those big buy and sell orders among their subscribers. In the United States, the most popular type is the electronic communication network, or ECN, which is basically a computerized system that automatically pairs up buy and sell orders for securities in the market.

Key Takeaways

You need to know that alternative trading systems are all about matching those large buy and sell transactions. They're not regulated as strictly as exchanges. Think of examples like dark pools and ECNs. And remember, SEC Regulation ATS sets up the regulatory framework for these venues.

Understanding an Alternative Trading System (ATS)

ATSs handle a significant portion of the liquidity in publicly traded issues around the world. In Europe, they're called multilateral trading facilities, but you might also hear terms like ECNs, cross networks, or call networks. Most ATSs register as broker-dealers instead of exchanges, and their main job is finding counterparties for transactions.

Unlike national exchanges, ATSs don't create rules for how subscribers behave or discipline them, except by kicking them out of trading. They're crucial for offering alternative ways to access liquidity.

If you're an institutional investor, you might turn to an ATS to find counterparties for your trades instead of dumping large blocks of shares on national stock exchanges. This keeps your trading hidden from the public eye, since ATS transactions don't show up on national exchange order books. The key advantage here is that it avoids the domino effect large trades can have on a stock's price.

Important Note

Just so you know, 'alternative trading system (ATS)' is the term used in the U.S. and Canada. In Europe, they're known as 'multilateral trading facilities.'

Criticisms of Alternative Trading Systems (ATSs)

These trading venues have to get approval from the SEC. Regulators have been cracking down more on ATSs for things like trading against customer order flow or using confidential customer trading info. Such violations might happen more often in ATSs than in national exchanges because of the lighter regulations.

Dark Pools

Take a hedge fund that's trying to build a big position in a company—it might use an ATS to stop other investors from jumping in ahead. When ATSs are used this way, they're often called dark pools.

Dark pools involve trading institutional orders on an ATS through private exchanges. The details of these transactions are mostly kept from the public, which is why they're labeled 'dark.' Most dark pool liquidity comes from block trades done away from central stock market exchanges, handled by institutional investors like investment banks.

Even though they're legal, dark pools run with minimal transparency. That's why they're frequently criticized in the finance world, especially alongside high-frequency trading (HFT). Some traders argue that these give an unfair edge to certain market players.

Regulation of Alternative Trading Systems (ATSs)

The SEC's Regulation ATS lays out the regulatory framework for ATSs. An ATS fits the definition of an exchange under federal securities laws but doesn't have to register as a national securities exchange if it operates under the exemption in Exchange Act Rule 3a1-1(a). To use this exemption, it must follow Rules 300-303 of Regulation ATS.

To stay compliant, an ATS has to register as a broker-dealer and submit an initial operation report on Form ATS to the Commission before starting up. It must also file amendments to Form ATS for any operational changes and a cessation report if it shuts down. These filing requirements are detailed in Rule 301(b)(2) of Regulation ATS, including mandates for books and records reporting.

There have been efforts to increase ATS transparency. For instance, in 2018, the SEC amended Regulation ATS to boost 'operational transparency.' This includes requiring detailed public disclosures about potential conflicts of interest and information leakage risks. ATSs also need written safeguards and procedures to protect subscribers' trading data.

Officially, the SEC defines an ATS as any organization, association, person, group of persons, or system that (1) creates or maintains a marketplace for bringing together buyers and sellers of securities or performs functions like a stock exchange under Rule 3b-16 of the Exchange Act; and (2) doesn't set conduct rules for subscribers beyond their trading on the system or discipline them except by excluding them from trading.

What Is the Difference Between OTC and ATS?

Over-the-counter (OTC) securities aren't listed on an exchange and trade directly between parties. Most of these trades happen on alternative trading systems. ATSs provide quotes from broker-dealers for OTC securities, with systems like Global OTC ATS and OTC Link ATS being key examples.

What Is the Difference Between an Exchange and an ATS?

A stock exchange is a highly regulated marketplace where buyers and sellers trade listed securities. An ATS is an electronic venue that also connects buyers and sellers, but it lacks regulatory responsibilities—though the SEC does regulate it—and it handles both listed and unlisted securities.

How Do Alternative Trading Systems Make Money?

ATSs earn revenue by charging fees and commissions on transactions. The more trades a user makes, the higher the costs to them and the greater the revenue for the ATS.

The Bottom Line

In summary, alternative trading systems facilitate large buy and sell orders between parties, typically institutional investors, which keeps those trades private and reduces the impact large orders would have on security prices in open public markets.