If you follow finance even casually, you’d be hard-pressed to have missed last year’s debate on equity market structure, technological advances, and the speed of trading. Some people are sensationalizing claims about the system’s flaws, pointing fingers and trying to find people to blame. Others are jockeying for position to use the controversy to protect their turf.
Underneath this turbulent surface, however, a surprisingly calm discussion is taking place. From exchanges to brokers, and from long-term investors to principal traders, there is broad consensus that U.S. equity markets are working well, and that market quality has improved in recent years as markets have become more electronic and more competitive.
Mary Jo White, Chair of the Securities and Exchange Commission, has repeatedly said that our markets are fundamentally sound. Copious data supports this conclusion and few experts dispute that truth. There is also an emerging consensus on many of the core issues at stake and on some of the structural changes required to improve market structure. Specifically, while details of how to get there differ, there is widespread agreement that the U.S. equity markets would benefit from more transparency, less complexity, and more efficient market data.
Quite a few market participants agree that we need more transparency into how orders are handled. This October, at the Baruch Financial Markets Conference, Brett Redfearn of JP Morgan Securities expressed support for more transparency and disclosure from alternative trading systems.
Joe Ratterman, CEO of BATS Global Markets testified before the Senate that, “the market has evolved significantly enough to warrant re-examining whether additional transparency could be provided that would benefit investors.”
FIA PTG has recommended that improved transparency be a cornerstone of any market reforms. All operational aspects of trading venues, including exchanges, alternative trading systems (ATS) and dark pools would benefit from more sunlight. We believe in particular, that markets and investors would benefit from greater clarity and insight into order matching, venue services, and order routing practices.
We also are advocating for reduced complexity in our markets. Regulatory policy, including Reg NMS, has subsidized the existence of more trading venues than would survive under normal competitive dynamics. While some complexity is inherent in the task of fairly and efficiently executing millions of trades across a large and diverse market, we are concerned about regulation that drives complexity without delivering sufficient benefits.
We’ll be releasing a more detailed paper on these issues this month—stay tuned for that.
Complexity is another area where there is general agreement on the principle, if not the specifics. At a Congressional roundtable on market structure, Congressman Scott Garrett invited testimony from a wide array of market participants, including FIA PTG Executive Committee member Pat Hickey. At that roundtable, Bob Greifeld, CEO of NASDAQ OMX, discussed the problems with Reg NMS: “Reg NMS was supposed to require best execution in the markets but no one knows what it means anymore. It has become virtually meaningless.”
Testifying before a Senate Committee, Tom Farley, President of the New York Stock Exchange, discussed the problems with complexity: “We have come to the view that the U.S. equities market is highly fragmented – making it overly complex and opaque. The regulations and structures in place today incentivize participants to make it more complex and more opaque.”
In an editorial published in the Wall Street Journal, Clifford Asness and Michael Mendelson of AQR Capital Management explain how automated trading has lowered costs for their clients. They go on to say that, “the biggest concern we have with modern markets is their complexity and the associated operational risks.”
Even regulators agree that fragmentation and complexity is problematic. In Chair White’s June speech on market structure, she said, “We also are continuing to consider whether more fundamental changes are needed to bring our regulatory structure in line with the significant market changes of the last decade. Importantly, we will be considering whether the SEC’s own rules, such as the trade-through rule of Regulation NMS, have contributed to excessive fragmentation across all types of venues.”
Improving Consolidated Market Data Feeds
The SEC has also pledged to look more closely at the Securities Information Processor (SIP). Commissioner Dan Gallagher spoke at the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality this fall and noted the lack of competition among consolidated data feeds: “Today, there are two exclusive primary information processors for equity transactions, one for consolidated transaction data and consolidated quotation data, the other for transactions executed pursuant to unlisted trading privileges… there is no competition for consolidated last sale and quotation reporting services between the SIPs.”
At the Security Traders Association (STA) Annual Market Structure Conference, Brandon Becker of TIAA-CREF discussed regulations that would facilitate market-based solutions, and recommended that regulators consider upgrading the SIP.
FIA PTG also recognizes the importance of consolidated feeds. We support efforts to increase the efficiency of the current consolidated feed structure, and recommend introducing competition for consolidated feeds, enhancing incentives for competitive feeds, and improving the performance of the SIP.
FIA PTG’s members appreciate the thoughtful discussion that’s taking place about market structure today. It’s encouraging that exchanges, investment managers, regulators, and principal traders are all finding areas of agreement on improving transparency, reducing complexity, and improving consolidated data feeds.
There are other, deeper structural issues that are affecting equities markets as well. And while there is not yet consensus on how to address these issues, there is at least a general commitment to using data analysis to develop solutions. That’s a good first step, because there’s one more principle that has probably earned universal approval—as Robert Gasser of ITG, Inc. said at the Georgetown conference: “Don’t regulate by anecdote.” We couldn’t agree more.