Empirical Evidence Central to Market Structure Debate

Terry Flanagan

The ramifications of market structure changes over the past decade—such as the advent of high-frequency trading, dark pools, and fragmentation of liquidity—are such that any attempt to overhaul the National Market Structure regulation must be grounded in empirical evidence.

“Experiment with pilot programs,” said Andrew Brooks, head of U.S. equity trading at T. Rowe Price, during a presentation at Baruch College. “It seems as if regulators are reluctant to encourage and adopt pilots. Every academic has a thirst for data. Let’s get the data.”

The Securities and Exchange Commission has launched an effort to seek out better sources of data to better assess today’s complex markets. These sources include MIDAS, the market information and data analysis system that the SEC staff began operating in January. The SEC also adopted the Large Trader Reporting Rule, which began last year to more efficiently collect information on most of the trading activity of key market participants, including high frequency traders.

In addition, the SEC adopted the Consolidated Audit Trail Rule, which, when implemented, should significantly enhance the ability of regulators to monitor the equity markets. In the meantime, SEC staff is using Finra’s existing audit trail data to analyze equity trading, particularly in the off-exchange markets.

“Our next immediate step is to start making this empirical information, which we are already using extensively, publicly available to help inform the broader market structure debate,” SEC chairman Mary Jo White said in an October 2 speech.

In order to promote a fuller empirical understanding of the equity markets, the SEC has prepared and assembled resources and data on the SEC’s web site focusing exclusively on equity market structure. The new web site will serve as a central location to publicly share evolving data, research, and analysis.

“Since Reg NMS, the industry has conducted a number of separate pilots around tick sizes, for example,” said John Donahue, head of equities at Fidelity Capital Markets. “A more holistic review of market structure is in order at this point. Mary Jo White said it’s time to have a thorough review based on empirical evidence.”

Part of the SEC initiative will be to disseminate data and related observations drawn from MIDAS that address the nature and quality of displayed liquidity across the full range of U.S.-listed equities –from the life-time of quotes, to the speed of the market, to the nature of order cancellations.

“We expect this new tool to transform the debate on market structure by focusing it as never before on data, not anecdote,” White said.

To modernize the national market structure, Brooks advocates abolishing maker-taker fees and payment for order flow, which he says do nothing to promote best execution and price discovery, and implementing a trade-at rule requiring dark pools to provide meaningful price improvement over listed prices, and to have a minimum execution size. “The average order size on some dark pools is less than the lit markets,” Brooks said.

Also, the trade-through rule, a key tenet of Regulation NMS, should be relaxed to enable markets to trade through prices on venues that have little or no market share. “A market center with de minimus market share should be ignored,” Brooks said. “If you have no depth to your quote, I should not be required to go to that market center.”

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