Alternative Trading Systems (ATS) offer a different avenue for trading securities than traditional exchanges, serving as regulated platforms that connect potential buyers and sellers. While they function similarly to national securities exchanges in matching orders, they are not classified as such. Unlike national securities exchanges, they provide a less formal, more flexible market structure. Although under the regulation of the SEC, an ATS maintains its unique identity by operating under its own set of rules, creating a niche marketplace for certain types of securities. It is noteworthy, however, that an ATS can apply to the SEC to upgrade its status to a national securities exchange if it wishes to adhere to more formal structures.
As mentioned above, an alternative trading system is registered with the SEC (Securities and Exchange Commission). It is registered as a broker-dealer, allowing it to trade exchange-listed stocks (i.e., publicly listed stocks). The SEC regulates ATSs but not as heavily as national exchanges such as the NYSE or NASDAQ.
An ATS is different from an OTC (over-the-counter) system. An OTC trades unlisted stocks rather than listed. The Financial Industry Regulatory Authority (FINRA) regulates OTCs.
When a trade is placed on a national exchange, the order is visible for all to see. That visibility provides an opportunity for other trades to front-run the price with a smaller order. This tactic will likely push the price higher for the original trader, potentially resulting in a lower return. If enough traders join in, the original trader might even suffer a loss if they are selling.
The term alternative trading system is specific to North America. Europe has a similar system but calls it a Multilateral Trading Facility (MTF).
ATSs are made up of different subsystems. Some examples include ECNs, Dark Pools, and Call Markets.
An Electronic Communication Network (ECN) is full digital trading. No human intervention is needed. Trades executed on an ECN can occur outside of regular market hours. ECNs do charge commissions, which can negatively impact returns for high-volume traders.
Dark Pools get their name because they completely hide trades from the public or obscure the size of trades. A trade may display 1,000 shares when the entire trade is 10,000 shares. This type of trade is called an iceberg because it only shows a small part of the trade. By not revealing the full size of the trade, the market is likely to move less against the trader.
Institutional traders utilize dark pools. They trade in large blocks and generally make arrangements with market makers who can find buyers and sellers for the other side of these large trades.
Cross Networks are another type of ATS similar to Dark Pools.
A Call Market waits until there is a certain amount of trades before trying to execute them. For that reason, trades do not execute continuously but instead at predetermined intervals or when the price reaches the clearing price. That price is determined by the securities being offered and the bids by buyers on the network.
Alternative trading systems are largely used by institutional traders trading in large sizes (called block trades). ATSs allow institutional traders to privately seek out buyers and sellers who might be a good match for larger trades. This is unlike a public exchange, which broadcasts trades to everyone on the exchange.