04.30.2018
By Rob Daly

OPINION: Everything Old is New Again

The US Securities and Exchange Commission is looking to turn back the regulatory clock to address the dearth of liquidity in thinly traded stocks.

During the industry roundtable regarding thinly traded stocks, the general conservation hosted by the SEC’s Division of Trading and Markets on April 23, two suggestions kept coming to the fore.

The representatives from the listing exchange backed the Department of the Treasury’s recommendation that issues of less-liquid stocks have the choice to suspend unlisted trading privileges fully partially.

The move would roll back the trading privileges of every exchange but the listing exchange that the Unlisted Trading Privileges Act of 1994 granted them.

Consolidating liquidity from the 13 exchanges down to a handful of exchanges, or the single listing exchange, is a simple answer to a complex problem. It also could lead to for-profit companies having trading and market data monopolies as noted by Cboe Global Markets’ Chis Concannon during the second of three roundtable panels.

The second solution, also floated by Concannon, would be to roll back portions of Regulation NMS instead. He never went into detail regarding which part of the regulation would need to go. It might be a return to a hybrid market with order-driven trading for the highly liquid stocks and a quote-driven market for the thinly traded one.

Deciding which trading model a stock should use could be an arbitrary decision by the regulators or a decision left up to each issuer given its importance.

Creating a hybrid market would not mean a return to a trading environment similar to that of the turn of the millennium. Technology and the role of the market participants have changed dramatically since the introduction of Regulation NMS. The market is far more fragmented today, and almost everyone has some version of a smart order router today. More importantly, the banks are no longer the market makers after the introduction of Dodd-Frank’s Volcker Rule.

However, Brett Redfearn, the director of Division of Trading and Markets, showed great interest in introducing intra-day auctions as a way to concentrate liquidity, saying that traders would show up out of fear of missing out on a significant portion of the average daily volume that would be done during an auction.

If the trading methodology is good enough for opening and closing crosses, it should be good enough for mid-day auctions too, right?

The immediate problem with mid-day auctions is the fear of information leakage as potential participants would pull their trades from the markets with continuous quotes in preparation for an auction.

The SEC could roll back the Reg NMS to enable issues only to trade in an auction model and thereby consolidate liquidity to fixed times rather than just geographically to one market or set of markets.

Adopting auctions on a single listing market would concentrate the most liquidity, but that might prove too radical a change for regulators.

This problem has been more than a decade in its making and isn’t going to be solved overnight. At least the industry has experience with the proposed trading methodologies, and the enabling technology exists for any future pilot.

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