At the North American Trading Architecture Summit, SEC Associate Director of the Office of Analytics and Research (Division of Trading and Markets) Gregg E. Berman delivered a speech discussing market complexity, market speed, and research that the Division of Trading and Markets has done to inform both of these topics.
Technological advances, Mr. Berman noted, “allow market participants to submit many thousands of quotes in less than a second on our national equity and options exchanges.” With the events of the past year in mind, Mr. Berman said, he asked whether the current market structure is (i) too fast and (ii) too complex. Mr. Berman stated that data-driven analysis can help inform the policy debate.
The research to which Mr. Berman first referred involved measuring the speed at which quotes are canceled, and at which market participants can lift quotes before they are canceled (See “The Speed of Equity Markets,” October 9, 2013). The results, according to Mr. Berman, suggest that the speed of systems that take liquidity by accessing displayed quotes seems to be keeping up with the speed at which those quotes can be canceled and, “thus, if you would like to slow the market down, you have to address both liquidity takers as well as liquidity providers.” Mr. Berman stated that these results, along with other data analyses, suggest that there may be a lot more to the debate about market structure than just high-speed cancellations.
Mr. Berman went on to note that the Office of Analytics and Research published additional findings that provided distinct distributions for quotes at or near the beginning of the book, instead of anywhere in the depth of the book (See “Equity Market Speed Relative to Order Placement,” March 19, 2014). According to Mr. Berman, the results are a straightforward measurement of the way market participants actually trade: “the data show that the majority of all displayed quoting activities occur in the depth-of-book, away from the inside spread.” Mr. Berman said that these results are unsettling because they suggest that liquidity takers focus their trading efforts on nothing more than what’s available at the National Best Bid and Offer (“NBBO”), and that he wondered whether there is “some fundamental mismatch between the nature of liquidity takers and liquidity makers.”
Mr. Berman also mentioned a white paper, published last October, in which SEC economists used FINRA OATS data to review off-exchange trading, the results of which suggested that “the buy-side uses the same algorithms in dark pools that they use on lit exchanges to slice up large orders into much smaller pieces to trade at the NBBO.” (See “Alternative Trading Systems: Description of ATS Trading in National Market System Stocks,” October 2013, Revised March, 2014). The results showed that almost half of all off-exchange institutional trades during the time of the research seem to have been executed by broker-dealers as part of smart-order router networks outside of a registered ATS platform. Mr. Berman stated that, based on all of this research, it seems that “a number of the complexities of market structure may, at least in part, be driven by the complex desires of market participants themselves.”
Mr. Berman concluded with a discussion of the products traded on the markets. He noted that “exchange-traded products, including exchange-traded funds, exchange-traded notes, and other similar vehicles” have grown in the past decade, and that keeping all of these products in line “requires a lot of quoting, canceling, and re-quoting.” He said that the Office of Analytics and Research measured a 21-month period and found that there was “a relatively stead cancel-to-trade message ratio of about 20-to-1 for corporate stocks.” (See “Market Activity Overview,” December 2013). Additionally, for every 1,000 shares quoted in corporate stocks, about 30 shares are traded; and for every 1,000 shares traded in exchange-traded products, 3 shares are traded. While these are not necessarily problematic or worrisome facts about exchange-traded products, Mr. Berman said, the products by construction require active quoting and canceling if investors want to receive fair prices when buying or selling the products.
As much as technology has driven complexity in the markets overall, Mr. Berman stated, he believes that “the desires of investors and investment managers – how they want to trade, the products they create, what they want to buy – requires an unavoidable increase in the complexity of our markets, and in a very real sense is also driving the need for more and faster technologies.”
Despite all of the attention that Michael Lewis’s recent book Flash Boys has generated, it seems to have missed the real issue. Those who participate in and regulate the financial markets know it’s not about good guys and bad guys, it’s about market structure and the government rules that create that structure.