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Cutting Through the Noise: The Only Question that Matters on Market Structure

Cutting Through the Noise: The Only Question that Matters on Market Structure

3 October 2014 5:00pm EDT

The U.S. equity markets are in the midst of a heated debate.  Depending on who you listen to you may think the debate is about whether high-frequency trading is good or bad for the market.  You may think the debate is about whether the market is rigged to favor some over others.  You may think that the debate is about the role exchanges play in market design and oversight.  You may even think that the debate is about the strengths and weaknesses of current regulation and policy. 

While it’s true that each of these topics is important to the ongoing discussion about equity markets, none of them fully addresses the real question: Is today’s equity market structure the best it can be to meet the needs of its participants?  

To say that is a complex question would be an understatement.  And, if you read our last blog entry, you’ll recall that the best way to answer a complex question is with rigorous data-driven analysis of observable market participant behaviors. 

While the U.S. equity markets have been heavily scrutinized in recent years, the data shows that these markets are, for the most part, working very well.  As competition and automation have increased, transaction costs have declined dramatically and today are among the lowest in the world.  Measures of price discovery and short-term volatility have improved, as well.  But while the foundation is solid and we should all be careful not to harm the parts of our markets that are working very well, some aspects of the U.S. equity market structure are due for renovation.

The current equity market structure has evolved over time in response to technological innovations, changing market conditions, and rules and regulations.  Each element of our market structure is interrelated, so it is risky to address any single rule or regulation in a vacuum.  Due to their interconnectedness, a small change in one structural issue may have an unforeseen, negative impact on another. That’s why, before making significant changes, we must understand how each facet of market structure impacts the others.  It’s like any other structure—during a renovation, you can’t start knocking down walls until you know which ones are load bearing and which hold the plumbing. 

That doesn’t mean that we shouldn’t attempt renovations, however.  All it means is that we need to be thorough and thoughtful in our analysis before making structural changes.  And as we conduct this analysis, we can begin to consider other reforms that aren’t central to the markets’ structural integrity. These are the easier and safer fixes—the maintenance and refinishing that make a house more livable.  We can begin improving our markets with similar changes.

Acknowledging this, in a recent speech SEC Chair Mary Jo White described the Commission’s near-term priorities for equity market structure policy.  That speech highlighted measured action that can be taken to increase market transparency and stability.  We have reviewed their plans and believe that many of them can enhance equity markets without adversely affecting the structure of the marketplace. 

We also believe that as principal traders, we can provide a valuable perspective on how best to achieve some of these goals.  To that end, we have published a paper that highlights key areas of reform

Specifically, we address the aspects of equity market operations that are in need of additional transparency, including how orders are routed to and matched by exchanges.  We describe what it means to offer fair market access.   We also offer up some actions that can be taken to improve consolidated market data feeds such as the Securities Information Processor (SIP) to the benefit of all market participants.

Taking these steps to capture the “low hanging fruit” will lead to immediate, positive market reform, without jeopardizing the parts of the markets that are working well today.  Enacting this reform will move us towards the ultimate goal of designing a market that best meets the needs of its participants while also giving us the time necessary to study available data, perform pilot programs and analyze their results.   Armed with that data we can tackle some of the more complex questions facing the equity markets and, ultimately, drive future action in safe and meaningful ways.

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