Alternative Display Facility (ADF) Orders Explained

What is the Alternative Display Facility (ADF)?

The Alternative Display Facility (ADF) is a piece of market infrastructure run by FINRA. Institutions use it to post quotes and report trades.

It’s called the Alternative Display Facility because the ADF is an alternative to an exchange for institutions to post quotes and report trades.

It’s basically where institutions can post quotes and report trades that don’t occur on a regular exchange. These off-exchange venues can be dark pools, internalized trades (where your broker or an affiliated party trades against you, ie, payment for order flow trades), or even straight-up negotiated trades, where two parties get on the phone and arrange a trade away from the exchange.

Of course, when these trades occur, they still have to be reported to the Consolidated Tape (time & sales). Still, because they didn’t happen on an exchange that automatically reports the trades, they must be reported on a different venue.

These trades don’t have to adhere to the National Best Bid and Offer (NBBO) rule from SEC’s NMS, meaning trades reported to the ADF can vary Regulation in price from the current best bid and offer.

This is where the ADF comes in. It enables such trade reporting.

Remember that, unlike an exchange, the ADF doesn’t have any hand in execution. It is simply a display-only facility where institutions can post quotes and report their trades. Any trades that are reported from the ADF were actually executed elsewhere.

But the ADF isn’t the only game in town. In fact, they’re a very insignificant player in the off-exchange trade reporting game.

The Alternative Display Facility (ADF) vs. the Trade Reporting Facility (TRF)

There are two primary pieces of off-exchange trade reporting infrastructure: the Trade Reporting Facility (TRF) and the Alternative Display Facility (ADF).

The difference is that the TRF is operated by exchanges, while FINRA runs the ADF.

The TRF is where 99.999% of off-exchange trades are reported. These are trades on dark pools, negotiated trades, internalized trades, and so on. Any over-the-counter trades, aka, not occurring on a lit exchange, are reported to the TRF.

By far, the TRF is the more prominent player, making it such that the ADF is pretty insignificant in the stock market.

In fact, according to FINRA, the operator of the ADF, there are currently zero quoting broker-dealers on the ADF as of now. There is, however, just one broker, JP Morgan, who uses the ADF for trade reporting.

The ADF isn’t supposed to be a competitor to the TRF. It was established in 2002 for a niche, outdated concern; for ECNs that didn’t want to post their quotes on NASDAQ’s books because they thought NASDAQ’s algorithms favored NASDAQ market makers instead of ECNs.

Regulation NMS essentially made the ADF obsolete and has been sparsely used since Reg NMS’ establishment in 2005.

Spotting A Whale On The ADF

Because the ADF is so sparingly used and used by only JP Morgan for trade reporting, it’s confusing why we would dedicate any time to the subject.

Let’s flashback to April 18, 2022, in the midst of a deep bear market in SPACs, there was a gigantic liquidation of SPAC warrants in extended-hours trading. SPAC warrants are essentially company-issued exotic call options on SPACs that are offered to SPAC investors as sweeteners.

Like any call option, a SPAC warrant has a calculable intrinsic value. If you can purchase these warrants below their intrinsic value, it’s like free money, although SPAC warrants typically can’t be exercised until a deal is announced.

Regardless, many traders took up this niche of playing the arbitrage of mispriced SPAC warrants.

This is why so many of them were looking at their cross-eyed montages on that April evening when massive block trades like a block of nearly 300,000 warrants for the SPAC McLaren Technology Acquisition Corp (MLAIW) went for just a penny, with several other SPAC warrant block trades taking place at ridiculous prices.

And these trades all were printed on the ADF, which is pretty peculiar.

You can never tell the story behind a trade; that is the nature of the US stock market structure. But it’s largely assumed that a hedge fund needed to quickly liquidate a portfolio of SPAC assets and negotiated an over-the-counter trade with another hedge fund.

Many traders were dumbfounded too. They had buy orders for these warrants well above the reported prices but were never filled, so what happened? These traders’ bids were sitting on the order books of stock exchanges like the NYSE. But this trade was negotiated and never touched an exchange, hence never triggering any buy orders. And because these trades don’t have to adhere to the NBBO, it’s completely legal.

From these block trades, an astute trader can make some insights; that at least one large fund heavily involved in SPACs is having liquidity problems and more fire-sales might be to come, which would surely be bearish for the SPAC market.

But you can make the same insights from trades reported on the TRF. So again, why the emphasis on the ADF?

Because JP Morgan is the only reporting participant on the ADF.

It’s not exactly clear why the ADF was used to report these trades, but on the rarer occasions when the ADF is used, the trades tend to hold more weight for whatever reason.

So you can simply look at reported volumes and if there’s a lot of trades being reported to the ADF, then you know that JP Morgan is actively trading the security. And for some reason if they’re reporting on the ADF, a catalyst might be upcoming.

Bottom Line

This market structure minutia can be boring, and the information published out there is all so technical in nature, making it hard to understand in practical terms.

For that reason, few traders take the time to explore, understand, and implement strategies based on this stuff. It’s nowhere as exciting as studying the newest chart pattern or technical indicator. And that’s exactly why it can be so rewarding.

With that said, the ADF is hardly used nowadays, with JP Morgan being the only participant, so you can’t expect to create a consistent trading strategy from it, but those rare times when you do spot an opportunity, doing that little bit of studying will have paid off.

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