The Time for Reform is Now
If not now, when?
For years, FIA PTG and others have been calling for equity market structure review and reform. Now more than ever, the time is ripe for action. Last month the Long-Term Stock Exchange became the 14th U.S. stock exchange, with several more on the near-term horizon. At the same time, there are hundreds of unique displayed and non-displayed order types, and more being added on a regular basis. We are all in favor of natural, healthy competition. We believe competition among trading venues and brokers has made the US equities market one of the most liquid and efficient markets in the world. However, the proliferation of venues and order types, artificially boosted by regulation, has resulted in an increasingly complex and unnecessarily costly market structure.
In June 2019, for all its strengths, the US equities markets have one of the most complex market structures in the world. This complexity has led to policymaking paralysis. There is a pervasive fear that because our current market structure is so complex, any changes would require a similar level of complexity and so we suffer from an endless cycle of paralysis by analysis. Meanwhile, rational-acting market participants continue to add venues and order types at significant cost to the industry as a whole, but at very little cost to themselves, making the system even more complex and fragile. Round and round we go…where we stop…at this point nobody knows.
It is not as if the market lacks reasonable ideas for reforms that would improve the current situation. For years, thoughtful groups have been putting together proposals for packages of reforms that would address many of the complexities and costs we are currently experiencing. We were heartened when Nasdaq, for example, recently released a paper, Total Markets – A Blueprint for a Better Tomorrow, calling for some of the same reforms that we called for in our paper, Reg NMS: A Retrospective Review & Practical Reforms for Improvement, released last September. The changes suggested by Nasdaq and FIA PTG are not identical and there are certain Nasdaq proposals that we would not support, but there seems to be agreement that in at least three areas, there is a need for reform: the Order Protection Rule, intelligent tick sizes and the Securities Information Processors (“SIPs”).
Where Nasdaq is calling for reform of the Order Protection Rule (Rule 611) by making it non-applicable to certain smaller stock exchanges, FIA PTG has called for its outright repeal. While FIA PTG acknowledges that the repeal of Rule 611 would raise certain technical questions, we believe such questions can be addressed in the context of a robust “best execution” framework. Europe, Japan and Australia have competing markets without rules like Rule 611. While these markets have healthy competition, they have not exhibited the same proliferation of trading venues. FIA PTG believes that the repeal of Rule 611 would, among other things, lead to a natural reduction in the number of exchange venues, thereby reducing marketplace complexity and the costs borne by investors. More importantly, it would reduce some of the inherent fragility in a marketplace tied together not by arbitrage and market forces but by intricate, unwieldy regulations.
Both Nasdaq and FIA PTG have suggested a more intelligent tick regime. While acknowledging that striking the right balance between optimal market efficiency and simplicity is a challenge; FIA PTG believes that the minimum increment for pricing orders is a critical component of market structure and the current one-size-fits-(almost)-all penny tick increment is not producing the ideal results for investors in many stocks. We have recommended that the SEC issue a concept release to collect ideas for a flexible tick size regime based on data from the Tick Size Pilot and other analyses, as well as experiences of other major global markets. In addition to potential changes based on the outcome of the concept release, the SEC should promptly implement a $.005 tick size for highly liquid securities, which currently trade at the minimum $.01 spread continuously throughout the day. This would provide dramatic cost savings to many investors trading in the most liquid stocks.
Both Nasdaq and FIA PTG have also similarly proposed SIP reform. Nasdaq suggests that we create more efficiency, choice, and industry participation in the SIPs through a series of important reforms. FIA PTG agrees with this general approach. We believe that allowing multiple, competing SIPs, would provide benefit to investors by way of reduced cost, improved service, and structural resilience. At the very least the existing equity SIPs—provided by Nasdaq and NYSE—should compete with one another. Allowing competing SIPs to collect and disseminate market data would further improve quality, reduce risk, and facilitate price competition.
Moving forward with U.S. equity market structure reform is complicated. It will be difficult. Many market participants have proposed thoughtful packages of reforms that could meaningfully improve our markets with lower costs, less complexity and more resilience. There are significant areas of agreement – and certainly some areas that would generate healthy debate, but the passage of time is not going to make the challenge any easier. Nor will we solve our concerns by continuing to simply avert our collective eyes to the complexity or wish away the unnecessary costs. We know, we’ve tried…
The time for reform is now.
About FIA PTG
FIA PTG is an association of firms that trade their own capital on exchanges in futures, options and equities markets worldwide. FIA PTG members engage in manual, automated, and hybrid methods of trading, and they are active in a wide variety of asset classes, including equities, fixed income, foreign exchange and commodities. FIA PTG member firms serve as a critical source of liquidity, allowing those who use the markets, including individual investors, to manage their risks and invest effectively. FIA PTG advocates for open access to markets, transparency, and data-driven policy.
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The priority should be to ensure continuity of cross-border services and avoid market fragmentation.
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With Adam Conn, Head of Trading, Baillie Gifford
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