Self-Regulatory Organizations; Cboe Exchange, Inc.; Order Granting Approval of a Proposed Rule Change, as Modified by Amendment No. 1, To Amend Cboe Rules 5.37 and 5.38 in Connection With Allocations at the Conclusion of the Exchange's Automated Improvement Mechanism (“AIM”) and Complex AIM (“C-AIM”) Auctions

I. Introduction

On April 14, 2021, Cboe Exchange, Inc. (the “Exchange” or “Cboe Options”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, a proposed rule change to adopt a Priority Order Plus status in connection with the allocation of exclusively listed index option classes at the conclusion of the Exchange's Automated Improvement Mechanism (“AIM” or “AIM Auction”) and Complex AIM (“C-AIM” or “C-AIM Auction”) auctions. The proposed rule change was published for comment in the Federal Register on May 3, 2021. The Commission received no comments regarding the proposal. On June 8, 2021, the Exchange submitted Amendment No. 1 to the proposed rule change. The Commission is approving the proposed rule change.

II. Description of the Proposed Rule Change

The AIM and C-AIM are electronic auctions intended to provide an Agency Order with the opportunity to receive price improvement (over the National Best Bid or Offer (“NBBO”) in AIM, or the synthetic best bid or offer (“SBBO”) on the Exchange in C-AIM). Upon submitting an Agency Order into one of these auctions, the initiating Trading Permit Holder (“Initiating TPH”) must also submit a contra-side second order (“Initiating Order”) for the same size as the Agency Order. The Initiating Order guarantees that the Agency Order will receive an execution. Upon commencement of an auction, market participants may submit responses to trade against the agency order. At the conclusion of the auction, the System allocates the Agency Order, taking into account all auction responses, unrelated orders, and quotes. Depending on the contra-side interest available, the Initiating Order may be allocated a certain percentage of the Agency Order. Any execution prices at the conclusion of an AIM Auction must be at or better than both sides of the BBO existing at the conclusion of the AIM Auction and at or better than both sides of the Initial NBBO, and any execution prices at the conclusion of a C-AIM Auction must be at or between the SBBO and the best prices of any complex orders resting on each side of the Complex Order Book (“COB”) at the conclusion of the C-AIM Auction.

Currently, the Exchange may offer Priority Order status to Users for allocations at the conclusion of an AIM Auction. If the Exchange designates a class as eligible for Priority Order status, then at the conclusion of an AIM Auction, Users with Priority Orders receive executions against the Agency Order after Priority Customers and the Initiating TPH have received their Agency Order allocations. Priority Order status is only valid for the duration of the particular AIM Auction.

The Exchange proposes to adopt a new Priority Order Plus status in connection with the allocation of exclusively listed index option classes at the conclusion of the Exchange's AIM and C-AIM auctions. An “exclusively listed option” is an option that trades exclusively on an exchange because the exchange has an exclusive license to list and trade the option or has the proprietary rights in the interest underlying the option.

A. Priority Order Plus and Priority Order Status in AIM

Proposed Rule 5.37(e)(4) would provide that the Exchange may designate any exclusively listed index option class as eligible for Priority Order Plus status and any class as eligible for Priority Order status. A class designated as eligible for one status would not be eligible for the other status. If the Exchange designates a class as eligible for Priority Order Plus or Priority Order status, Users would have priority for their contra-side interest Priority Orders up to their size in the Initial NBBO at each price level at or better than the Initial NBBO. Each status is only valid for the duration of the particular AIM Auction.

The proposed rule change amends Rule 5.37(e)(1)(B), which describes the allocation priority where the AIM results in no price improvement to the Agency Order, to provide that Users with Priority Order Plus status may be allocated directly following Priority Customer allocations but prior to Initiating TPH allocations. The proposed rule change also amends Rule 5.37(e)(2)(B), which sets forth the allocation priority where the AIM results in price improvement and the Initiating TPH has selected a single-price submission, to provide that Users with Priority Order status or Priority Order Plus status (as designated by the Exchange) may be allocated directly following Priority Customer allocations.

Additionally, proposed Rule 5.37(e)(1)(B) would provide that Priority Orders eligible for Priority Order Plus status are allocated in a pro-rata manner. Likewise, the proposed rule change updates Rules 5.37(e)(1)(C) and (D) and (e)(2)(B), (C) and (D) to reflect that Priority Orders, all other contra-side interest (including AIM responses and orders and quotes on the Book) and non-Priority Customer non-displayed Reserve Quantity pursuant to these Rules are allocated in a pro-rata manner.

B. Priority Complex Order Plus Status in C-AIM

With respect to allocation priority in C-AIM, the proposed Rule 5.38(e)(4) would permit the Exchange to designate any exclusively listed index option class as eligible for Priority Complex Order Plus status, pursuant to which proposed Priority Complex Orders may receive Agency Order executions after Priority Customers at the conclusion of a C-AIM Auction. Specifically, proposed Rule 5.38(e)(4) provides that, if the Exchange designates a class as eligible for Priority Complex Order Plus status, Users with contra-side complex interest at the conclusion of the C-AIM Auction and displayed resting quotes and orders that were at a price equal to the BBO on the opposite side of the market from any of the components of the Agency Order at the time the C-AIM Auction commenced (“Priority Complex Orders”), have priority in their contra-side complex interest up to their largest size in a BBO in a pro-rata manner (after Priority Customers have received allocations, as set forth in subparagraphs (e)(1) through (3) above). Priority Complex Order Plus status is only valid for the duration of the particular C-AIM Auction. The proposed change also adopts new Rules 5.38(e)(1)(B) and 5.38(e)(2)(B), which provide for the allocation of Priority Complex Orders (in a pro-rata manner), if the Exchange has designated the class as eligible for Priority Complex Order Plus status, immediately following Priority Customer allocations and prior to any Initiating TPH allocations, pursuant to Rule 5.38(e)(1)(A) (if the C-AIM Auction results in no price improvement) and Rule 5.38(e)(2) (if the C-AIM Auction results in price improvement for the Agency Order and the Initiating TPH selected a single-price submission).

III. Discussion and Commission Findings

After careful review, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange and, in particular, with Section 6(b) of the Act. In particular, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act, which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest, and that the rules of a national securities exchange not be designed to permit unfair discrimination between customers, issuers, brokers or dealers. The Commission believes that the proposed new Priority Order Plus allocation status may encourage further competition in the AIM and C-AIM in exclusively listed classes, by encouraging aggressive quoting from Users. According to the Exchange, price improvement auctions have provided the market with benefits (such as providing an efficient manner of access to liquidity for customers), however, the options industry overall has observed that quoted liquidity on the book has decreased, quotes have widened, and options market makers have reduced their participation in the market, which the Exchange believes has impacted market quality. By providing market participants, particularly Market-Makers and other liquidity providers, the opportunity to receive priority over the Initiating TPH in exclusively listed index classes if they post more aggressive markets, the Commission believes the potential for increased competition within an individual AIM or C-AIM auction may enhance displayed liquidity, provide for tighter markets, and ultimately provide better execution prices for all market participants in classes available exclusively for trading on the Exchange.

While the Commission recognizes that the loss of Initiating TPH priority to Users with Priority Order Plus status may potentially result in fewer auctions being initiated, the Commission believes that those individual auctions should be more competitive, as Users may be encouraged by the prospect of Priority Order Plus status to submit competitive orders/quotes. This may benefit the Agency Order by providing more opportunity for price improvement within an individual auction. The AIM Auction in particular should benefit from potentially increased competition, especially since the AIM Auction no longer provides guaranteed price improvement for smaller orders (except where the NBBO spread is $0.01).

The Commission also believes that updating the allocation of Priority Orders and other contra-side interest (including non-Priority Customer non-displayed Reserve Quantity) to be pro-rata for all AIM- or SAM-eligible classes (as applicable), as opposed to price-time, may enhance competition by encouraging market participants to bring more liquidity into the auctions and provide competitive bids and offers throughout an auction. The Commission notes that pro-rata allocation is consistent with the manner in which other options exchanges allocate agency orders at the conclusion of comparable price improvement auctions and solicitation auctions on those exchanges. Further, the proposed pro-rata allocation for Priority Orders and all other contra-side interest at the conclusion of an AIM Auction is consistent with the manner in which the same orders currently receive allocations at the conclusion of an AIM auction on the Exchange's affiliated options exchange, Cboe EDGX Exchange, Inc. (“EDGX Options”).

IV. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act, that the proposed rule change (SR-CBOE-2021-025), is approved.