U.S. Equity Market Structure: Gut Reno or Refurbish?

Terry Flanagan

If one were to ask market participants for opinions on U.S. equity market structure, the one guarantee is that nobody would call it optimal.

Beyond that, one could expect a wide range of perspectives, ranging from just a few tweaks are needed, all the way up to it’s time to tear it down and rebuild from scratch.

Early last year, Michael Lewis’s Flash Boys infamously called U.S. equity market structure ‘broken’, ruined by dens of nefarious high-frequency traders and their Wall Street enablers. But sensationalism aside, corporations continue to tap the stock market for capital, and end-user investors continue to build long-term investment plans around equities.

In other words, U.S. equity market structure functions at a reasonably high level, with room for improvement of course.

“Are we talking about making things incrementally better for people, or is the whole thing just completely broken? I think the general consensus is that it is not completely broken,” said Eric Noll, president and chief executive officer at agency brokerage ConvergEx Group. “Conceptually it sounds good that we should look at everything, but it seems unlikely that we’d go through a whole tear-down. So the real question is what needs fixing?”

Eric Noll, ConvergEx

Eric Noll, ConvergEx

“There are things that need work,” said Noll, a member of the U.S. Securities and Exchange Commission’s Equity Market Structure Advisory Committee. “For example, price discovery for small and mid-cap stocks; how do you guard against latency arbitrage; resiliency of market infrastructure; and, how do you give the end-user market participant primacy over market intermediaries?”

The SEC has stated that U.S. equity market structure is a regulatory priority. In June 2014, SEC Chair Mary Jo White rattled some cages when she proposed bolstering oversight of high-frequency traders and shining light on ‘dark’ trading venues, as part of a broader plan to enhance market structure. The agency has continued to beat the market-structure drum, and market participants and observers expect further steps to be announced as soon as this year.

But aside from the prevailing view — even espoused by Chair White — that equity market structure is not broken, there are other reasons to believe that remedies are more likely to take the form of tactical, one-off repairs, rather than a complete overhaul.

One reason is the limited bandwidth of the SEC itself. Many market participants say the top cop for U.S. securities markets has grown more savvy and nimble in recent years and it’s generally on the right track in terms of its broader initiatives. But, the SEC’s budget is tight and the agency still moves slowly amid rapidly evolving markets, so a comprehensive revamp could be obsolete by the time it’s finalized.

Additionally, recent press reports have cited former SEC officials as saying the regulator has become dysfunctional and increasingly gridlocked over the past few years, and earlier this month, outgoing SEC Commissioner Daniel Gallagher criticized what he perceived as the agency’s piecemeal approach.

Featured image by showcake/Dollar Photo Club

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