Alternative Trading Systems (ATS): a clear explainer
Definition
– Alternative trading system (ATS): a trading venue that brings buyers and sellers together electronically but is not a national securities exchange. In the U.S. an ATS is typically registered as a broker‑dealer and must comply with SEC rules for ATSs, but it does not perform the broader rule‑making and disciplinary roles that an exchange does.
What ATSs do, in plain terms
– Match orders—often large institutional buy or sell orders—outside the visible order books of national exchanges.
– Operate as electronic communication networks (ECNs), cross networks, call networks, or, in Europe, multilateral trading facilities (MTFs).
– Provide alternative sources of liquidity for both listed and some unlisted (over‑the‑counter, OTC) securities.
– Offer greater privacy for large trades; this can reduce the immediate market impact that a big order would cause on a public exchange.
Key differences (short)
– ATS vs exchange: An exchange lists securities, sets member rules, and enforces those rules. An ATS focuses on matching trades and generally does not set or enforce subscriber conduct rules beyond excluding participants from the platform.
– ATS vs OTC: OTC trading refers to securities not listed on an exchange that trade directly between parties. Some OTC activity
Some OTC activity occurs through broker‑dealer networks rather than on centralized platforms; ATSs can sometimes facilitate OTC trades by matching counterparties without listing the security on a public exchange.
Regulatory framework (short)
– United States: ATSs must register as broker‑dealers and comply with Regulation ATS. They file Form ATS with the SEC to describe how the system operates and to make certain disclosures to the regulator. Broker‑dealers that use or operate ATSs also remain subject to general securities laws, anti‑fraud provisions, and broker‑dealer rules (including trade reporting and best‑execution obligations).
– Europe: Similar trading venues are called multilateral trading facilities (MTFs) or organized trading facilities (OTFs) under MiFID II. These venues face transparency, reporting, and conduct rules calibrated to venue type.
– Other jurisdictions: Rules vary, but common themes are registration, reporting, surveillance, and requirements to prevent market abuse.
Common ATS types (definitions)
– Electronic Communication Network (ECN): An ECN is an automated system that matches buy and sell orders electronically. It posts limit orders and shows executable liquidity to subscribers.
– Dark pool: A trading venue that does not display pre‑trade order information publicly (pre‑trade transparency). It gives anonymity to large traders but reduces visible liquidity.
– Crossing network / midpoint matcher: Matches buy and sell orders at a midpoint price (between bid and ask), often to seek price improvement for large orders.
– Internalizer / internal crossing: A broker‑dealer matches client orders against its own inventory or against other clients without routing to an exchange or public ATS.
Advantages of using ATSs
– Reduced market impact for large orders through hidden or midpoint executions.
– Potential price improvement versus executing at the displayed bid/ask on an exchange.
– Extended or alternative execution hours and order types.
– Specialized matching logic that can prioritize size, anonymity, or speed.
Risks and drawbacks
– Fragmentation: Liquidity dispersed across many venues can widen overall market spreads and complicate best‑execution decisions.
– Transparency tradeoff: Dark pools reduce pre‑trade transparency, which can distort price discovery.
– Information leakage: Order exposure to many counterparties can reveal trading intent.
– Conflicts of interest: Some operators internalize flow or provide access preferentially.
– Execution uncertainty: Orders placed in crossing networks may not fill, requiring fallback routing that can increase cost.
Practical checklist for traders (step‑by‑step)
1. Identify the venue: public exchange, ECN, dark pool, or broker internalizer.
2. Check execution quality metrics: past fill rates, average execution price vs NBBO (national best bid and offer), latency, and slippage statistics offered by the venue or by your broker.
3. Confirm access terms: membership or sponsored access, fees, rebates, and minimum order sizes.
4. Understand order types: visible limit, reserve (hidden), midpoint match, pegged, and cancels.
5. Test with a small order: measure real fills and slippage; compare against exchange executions.
6. Monitor and log executions: record timestamp, executed price, venue, and order details for compliance and post‑trade analysis.
7. Have a fallback plan: set time or percentage thresholds to route unfilled portions to an exchange.
Worked numeric example (illustrative
Worked numeric example (illustrative only):
Order: buy 10,000 shares of XYZ.
– NBBO (national best bid and offer): 20.00 – 20.02 → midpoint = 20.01.
– ATS behavior (historical
– ATS behavior (historical fills): 40% of volume matched at midpoint, 30% posted at price improvement (aggressively priced limit resting inside the NBBO), and the remaining 30% routed out and executed on an exchange at/near the offer.
Using that behavior, we can walk through the math.
Assumptions (explicit)
– Order: buy 10,000 shares of XYZ.
– NBBO (national best bid and offer): 20.00 – 20.02 → midpoint = 20.01.
– ATS fills: 4,000 shares at midpoint = $20.01; 3,000 shares at price improvement = $20.00; 3,000 shares routed off‑ATS and executed at $20.03.
– Fees/commissions (illustrative): broker commission = $0.002 per share; exchange taker fee on routed fills = $0.003 per share; assume no ATS fee or ATS rebate for simplicity.
Step‑by‑step fill math
1. Dollar fills by venue:
– ATS midpoint: 4,000 × $20.01 = $80,040
– ATS improved: 3,000 × $20.00 = $60,000
– Exchange routed: 3,000 × $20.03 = $60,090
– Total dollars paid = $80,040 + $60,000 + $60,090 = $200,130
2. Volume check:
– Total shares = 4,000 + 3,000 + 3,000 = 10,000 (matches order)
3. Volume‑weighted average price (VWAP) / average execution price:
– VWAP = Total dollars / Total shares = $200,130 / 10,000 = $20.013 per share
4. Execution cost relative to NBBO midpoint:
– Midpoint = $20.01
– Per‑
‑share cost = VWAP − Midpoint = $20.013 − $20.01 = $0.003 per share (0.3¢)
– Total dollar cost relative to midpoint = $0.003 × 10,000 = $30
(Check: midpoint dollars = $20.01 × 10,000 = $200,100; actual dollars paid = $200,130; difference = $30)
5. Fees and net execution cost
– Assumptions from above: no ATS fee/rebate; exchange taker fee on routed fills = $0.003 per share; exchange maker rebate not applicable here.
– Exchange fees paid = routed shares × taker fee = 3,000 × $0.003 = $9
– Net total cost (slippage + fees) = $30 (execution vs midpoint) + $9 (exchange fees) = $39
– Net per‑share cost = $39 / 10,000 = $0.0039 per share (0.39¢)
– Net cost as a percentage of VWAP ≈ $0.0039 / $20.013 ≈ 0.0195% ≈ 0.02%
6. Quick checklist for calculating execution quality (use this on any trade)
– Capture: record fills by venue, shares, and execution price.
– Verify volume: sum shares across venues equals order size.
– Compute dollars paid per venue = shares × price; sum to get total dollars.
– VWAP = total dollars / total shares.
– Compare VWAP to benchmark (NBBO midpoint, arrival price, or previous close) to measure slippage.
– Add explicit fees (exchange taker/maker, ATS fees, routing fees) to get net cost.
– Express results in per‑share cents and percentage terms for easy comparison.
Worked numeric summary (this example)
– Order size = 10,000 shares
– VWAP = $20.013
– NBBO midpoint = $20.01
– Execution slippage = $0.003 per share = $30 total
– Exchange taker fees on routed fills = $9
– Net cost (slippage + fees) = $39 total = $0.0039 per share ≈ 0.02%
Notes and assumptions
– NBBO midpoint (National Best Bid and Offer midpoint) is used here as the benchmark; other benchmarks (arrival price, decision price, VWAP over the day) can be preferred depending on the trading objective.
– We assumed no ATS fees or rebates; some ATSs charge a per‑share fee or offer
– We assumed no ATS fees or rebates; some ATSs charge a per‑share fee or offer a per‑share rebate for executions. Include those explicitly when you tally net cost, because a small fee or rebate can change relative economics when per‑share slippage is low.
Additional notes and caveats
– Hidden liquidity and execution timing — Many ATSs (including dark pools) display little or no pre‑trade information. That can reduce visible market impact but may increase the chance your order receives inferior prices if the ATS matches against stale or informed counterparties.
– Fill uncertainty — Execution may be partial or arrive in multiple tranches. When measuring performance, use fill‑weighted averages and report partial fills separately.
– Access and routing costs — Some brokers charge add‑ons for accessing certain ATSs, or they bundle ATS access into exchange connectivity fees. Confirm with your broker how those are charged (per order, per share, monthly).
– Reporting latency — Trade reporting time (how quickly fills are published to public tape) affects how representative the NBBO or VWAP benchmarks are at the time of execution. Faster reporting generally yields more reliable benchmarking.
– Regulatory status — ATSs must generally register with the Securities and Exchange Commission (SEC) under Regulation ATS and comply with applicable self‑regulatory organization (SRO) rules. Confirm the ATS’s registration and any relevant rule filings if regulatory compliance matters for you.
Practical checklist before sending an order to an ATS
1. Define your benchmark and objective (example: minimize implementation shortfall vs. NBBO midpoint; or achieve VWAP).
2. Check the ATS fee schedule (per‑share fee or rebate, connectivity charges).
3. Confirm order types and execution protocols supported (limit, midpoint, pegs, conditional instructions).
4. Ask about typical matching latency and average fill rates for your order size.
5. Review historical execution statistics if available (average trade size, volume at midpoints, percentage of passive vs. aggressive fills).
6. Consider counterparty mix (institutional crossing, retail flow, high‑frequency market‑making) — this affects adverse selection risk.
7. Test with a small pilot order and measure slippage and fill patterns before scaling.
Worked example — effect of ATS fee or rebate on the earlier numeric summary
– Starting results from earlier example: Order size = 10,000 shares; VWAP = $20.013; NBBO midpoint = $20.01; execution slippage = $0.003 per share = $30; exchange taker fees = $9; net cost = $39 = $0.0039 per share.
– Case A: ATS charges $0.001 per share → extra cost = $10 → new net cost = $49 → per‑share = $0.0049 ≈ 0.0245%.
– Case B: ATS offers a $0.001 per‑share rebate → benefit = $10 → new net cost = $29 → per‑share = $0.0029 ≈ 0.0145%.
These differences are small in absolute dollars for this 10,000‑share example but scale linearly with order size and can change venue preference for large institutional flows.
How to measure ATS execution quality (simple metrics)
– Per‑share net cost = (Average execution price − Benchmark price) + per‑share fees − per‑share rebates.
– Implementation shortfall (%) = [(Execution price − Decision price) / Decision price] × 100, where Decision price is the price when the trading decision was made.
– Fill rate = Executed shares / Submitted shares.
– Time‑to‑fill = Average elapsed time from order submission to execution.
Report these metrics both in absolute terms and split by fill tranche, order type, and time bucket.
Common ATS types (brief)
– Dark pools — No pre‑trade display of order interest; focused on large crosses.
– Midpoint/peg venues — Match at the NBBO midpoint or pegged reference price.
– Crossing networks — Scheduled or continuous crosses that match buy/sell interest.
– Broker‑internalizers and sponsored ATSs — Broker‑run pools that may favor internal flow.
Risks and mitigations
– Adverse selection: Use smaller pilot slices or randomized arrival times; prefer midpoint or passive-only order instructions.
– Information leakage: Minimize displayed limit orders; consider using midpoint peg orders that only execute at reference prices.
– Liquidity mismatch: Split large orders across multiple venues and include minimum fill sizes or conditional instructions to avoid small, unfavorable fills.
Summary checklist to evaluate an ATS for a trade
– Is the trade objective aligned with the ATS matching logic?
– Are all explicit fees and implicit costs (slippage, delay) quantified?
– Have you tested with small orders and captured performance statistics?
– Do you have rules (or a broker service) to split and route across multiple venues to avoid concentration risk?
– Are regulatory filings and reporting latency acceptable for your compliance needs?
Educational disclaimer
This information is educational and does not constitute individualized investment advice, trading recommendations, or an offer to buy or sell securities. Always consult your broker, compliance officer, or a licensed professional before changing trading strategies.