Exchange Executive Outlines Market Structure Concerns

Terry Flanagan

Recent high-profile exchange glitches have left investor confidence at lows not seen in almost a century, said an exchange executive, but other market participants believe that despite these incidents the U.S. equity markets are still among the fairest in the world.

“Investor confidence in U.S. equity market structure is perhaps at its lowest point since the Great Depression [of the late 1920s and early 1930s],” said William O’Brien, chief executive of U.S. exchange operator Direct Edge, in written testimony presented at a recent hearing before a House of Representatives Committee on Financial Services.

O’Brien was joined at the hearing by, among others, fellow exchange chief executive Duncan Niederauer from NYSE Euronext as well as the heads of market making firms Getco and Knight Capital Group.

“As exchange operators, our main job is to be the stewards of investor confidence,” said Bryan Harkins, chief operating officer of Direct Edge at a conference earlier this week. “Despite all of the exchanges competing with each other, at the end of the day we want what’s right for market structure.”

Despite the hit on investor confidence in the wake of the botched Facebook IPO, as well as a similar incident with Bats Global Markets’ own IPO a few months prior, in addition to the May 6, 2010 ‘flash crash’, when the Dow Jones Industrial Average index plunged 1,000 points, almost 9%, only to recover within minutes, for the most part market participants believe that things are as good now as they’ve ever been.

“The U.S. equity market is the best functioning and the fairest market globally,” said Tom Joyce, Knight chairman and chief executive, in his prepared statement to the committee. “There has never been a better time to be an investor (large or small) in U.S. equities. Remember that during the course of the last few years, with the exception of [a couple of] notable exceptions, the equity markets have worked flawlessly.”

Joyce recommended widening quote increments from one cent, banning rebates to liquidity takers and forcing market makers to keep their bid and offer quotes in the market for at least a second before canceling them.

The technical issues surrounding the Facebook IPO, with its exchange, Nasdaq, which suffered a paralyzing computer malfunction during the first hours of the IPO, leading to tens of millions of dollars in trades being wrongly placed, have undoubtedly been a black eye for the entire market. Nasdaq OMX Group, the operator of the exchange, with its lack of communication and information in the immediate aftermath, and its proposed compensation scheme, have each been ridiculed by market participants as anti-competitive.

“The proposal to compensate the industry with fee reductions or discounts is the wrong way to go,” said Joe Mecane, executive vice-president and co-head of the U.S. listing and cash execution unit at NYSE Euronext. “Tying the payment to the level of business you do at the exchange as an incentive to get paid faster is the wrong way to go.”

Observers have also noted that the all-electronic nature of the Nasdaq exchange was a crutch for the venue during the incident.

“It is why we have human intervention at different parts of our market,” added Mecane. “A fully electronic exchange is highly efficient 99.9% of the time, but if a problem does arise it is catastrophic. Having the human element is one form of contingency planning.”

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