What Is an Alternative Trading System (ATS)? Rules and Regulations

What Is an Alternative Trading System (ATS)?

Alternative trading systems (ATSs) are platforms that match large buy and sell orders. They are often used by institutional investors to trade efficiently outside traditional exchanges. Although they are less regulated than national exchanges, they are an important part of market liquidity and price discovery. These systems operate under SEC regulations that set transparency and operational standards. Types of ATSs include dark pools, which allow large trades to occur privately without immediately affecting market prices.

Key Takeaways

Alternative trading systems (ATSs) offer a platform for executing large buy and sell orders, providing anonymity and limiting market impact compared to trading on public exchanges.
Most ATSs operate as broker-dealers rather than formal exchanges, allowing them to bypass some strict regulations faced by national stock exchanges.
Dark pools, a type of ATS, enable institutional investors to trade large blocks of shares discreetly, but they face criticism for their lack of transparency.
SEC Regulation ATS mandates that ATSs meet certain requirements, such as registration and public disclosures, to increase transparency and protect traders.
Over-the-counter (OTC) trades often occur on ATS platforms, where quotes are shown from broker-dealers, distinguishing them from exchange-listed transactions.

Deep Dive into Alternative Trading Systems

ATSs account for much of the liquidity found in publicly traded issues worldwide. They are known as multilateral trading facilities in Europe, ECNs, cross networks, and call networks. Most ATSs are registered as broker-dealers rather than exchanges and focus on finding counterparties for transactions.

Unlike some national exchanges, ATSs do not set rules governing the conduct of subscribers or discipline subscribers, other than by excluding them from trading. They are important in providing alternative means to access liquidity.

Institutional investors may use an ATS to find counterparties for transactions, instead of trading large blocks of shares on national stock exchanges. These actions may be designed to conceal trading from public view since ATS transactions do not appear on national exchange order books. The benefit of using an ATS to execute such orders is that it reduces the domino effect that large trades might have on the price of an equity.

Important

"Alternative trading system (ATS)" is the terminology used in the U.S. and Canada. In Europe, they are known as "multilateral trading facilities."

Exploring Criticisms of Alternative Trading Systems

ATSs need SEC approval. Regulators are taking stricter actions against ATSs for violations like trading against customer orders or misusing confidential information. These issues might be more frequent in ATSs than national exchanges due to fewer regulations.

Understanding Dark Pools in ATSs

A hedge fund interested in building a large position in a company may use an ATS to prevent other investors from buying in advance. ATSs used for these purposes may be referred to as dark pools.

Dark pools entail trading on an ATS by institutional orders executed on private exchanges. Information about these transactions is mostly unavailable to the public, which is why they are called "dark." The bulk of dark pool liquidity is created by block trades facilitated away from the central stock market exchanges and conducted by institutional investors (primarily investment banks).

Dark pools, despite being legal, lack transparency. They, along with high-frequency trading (HFT), often face criticism as some traders believe they give certain market players an unfair advantage

How Alternative Trading Systems Are Regulated

SEC Regulation ATS established a regulatory framework for ATSs. ATSs qualify as exchanges under federal law but don't have to register as national securities exchanges if they operate under the Exchange Act Rule 3a1-1(a) exemption. To operate under this exemption, an ATS must comply with the requirements in Rules 300-303 of Regulation ATS.

To comply with Regulation ATS, an ATS must register as a broker-dealer and file an initial operation report with the Commission on Form ATS before beginning operations. An ATS must file amendments to Form ATS to provide notice of any changes to its operations and must file a cessation of operation report on Form ATS if it closes. Rule 301(b)(2) of Regulation ATS details the reporting requirements for Form ATS, including mandatory reporting of books and records.

There have been moves to make ATS more transparent. In 2018, the SEC amended Regulation ATS to improve "operational transparency." It now requires detailed public disclosures about potential conflicts of interest and information leakage risks. ATSs are also required to have written safeguards and procedures to protect subscribers' trading information.

The SEC formally defines an alternative trading system as "any organization, association, person, group of persons, or systems (1) that constitutes, maintains, or provides a marketplace or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange within the meaning of Rule 3b-16 under the Exchange Act; and (2) that does not (i) set rules governing the conduct of subscribers other than the conduct of such subscribers' trading on such organization, association, person, group of persons, or system, or (ii) discipline subscribers other than by exclusion from trading."

What Is the Difference Between OTC and ATS?

Over-the-counter (OTC) securities are securities that are not listed on an exchange. They trade between parties directly. Most of these trades are completed on alternative trading systems (ATS). ATSs show quotes from broker-dealers for OTC securities. There are two such interdealer quotation systems: Global OTC ATS and OTC Link ATS.

What Is the Difference Between an Exchange and an ATS?

A stock exchange is a heavily regulated marketplace that brings together buyers and sellers to trade listed securities. An ATS is an electronic venue that also brings buyers and sellers together; however, it does not have any regulatory responsibilities (though it is regulated by the SEC) and trades both listed and unlisted securities.

How Do Alternative Trading Systems Make Money?

Alternative trading systems make money by charging fees and commissions for transactions. The more trades a trader makes, the more cost to them and more sales revenue for the ATS.

The Bottom Line

ATSs provide a less regulated environment than traditional exchanges. They let institutional investors execute large trades discreetly with minimal market impact. While they offer efficiency and privacy, their limited transparency comes with risks and attracts regulatory scrutiny. SEC Regulation ATS sets guidelines to improve oversight and maintain market integrity, but there are concerns about the misuse of confidential information. As a result, there is a push for greater transparency and disclosures to reduce conflicts of interest in these trading systems.