The Trade-At Rule, Internalization, and Market Quality

Abstract

The SEC is considering the imposition of a trade-at rule which requires venues not at the inside to either significantly improve on price or route to a venue that is quoting at the inside. The rule is expected to greatly reduce the internalization of order flow either directly or through dark pools established to allow indirect internalization. This paper finds that internalization (direct and indirect) is associated with wider spreads (quoted, effective, and realized), higher price impact per trade, and increased volatility. I conclude that imposing a trade-at rule on US markets would improve the quality of markets.

Keywords: Trade-at; internalization; market quality; dark pool

JEL Classification: G12, G14, G18