SEC Chair Mary Jo White delivered significant remarks concerning SEC initiatives on equity market structure. Her speech covered important subjects including algorithmic trading, exchange fees, and a possible review of the authority of the securities exchanges as self-regulatory organizations. Chair White stated that, despite rumors about the current market structure being fundamentally broken or rigged, empirical evidence shows that investors are doing better in today’s technology-dominated marketplace than they did in the older manual markets. However, she conceded, potential additional benefits for investors from improved technology may have been lost by excessive intermediation, and broad market quality might improve with better rules. She also noted that, as a general matter, many market structure rules and industry practices were developed with manual markets in mind and, accordingly, are now outdated.
To address issues in the current market structure, Chair White highlighted various initiatives that are being advanced by the SEC, including those that address market instability, high-frequency trading, market fragmentation, broker conflicts and the quality of markets for smaller companies.
Chair White stated that, while there is more to be done to address the risk of instability and disruption in the markets, a number of initiatives have already been undertaken, such as “limit up-limit down,” market-wide circuit breakers, the Market Access Rule and Regulation SCI.
Chair White stated that, while the SEC should not do anything to prohibit algorithmic trading or its technology, the SEC should assess the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them. In particular, Chair White suggested focusing on the use of aggressive, destabilizing trading strategies in vulnerable market conditions that could exacerbate price volatility. She explained that she has directed the SEC staff to develop a number of recommendations for the SEC to address this and other issues, including:
- an anti-disruptive trading rule;
- a rule to clarify the status of unregistered active proprietary traders to subject them to SEC rules as dealers;
- a rule eliminating an exception from FINRA membership requirements for dealers that trade in off-exchange venues; and
- recommendations on how to improve firms’ risk management of trading algorithms and enhance regulatory oversight for their use.
As an initial step, Chair White said that she would continue to focus the efforts of the exchanges and FINRA toward minimizing consolidated data latency, and has asked them to consider including a time stamp in consolidated data feeds to better monitor the latency of feeds and address whether they meet requirements. Chair White also noted that she has asked the exchanges to develop proposed rule changes to disclose how and for what purpose they are using data feeds.
Chair White explained that, while the many trading venues (for order flow in exchange-listed equities) benefit investors by encouraging services that meet particular trading needs and by keeping trading fees low, there are also issues. The interconnectedness of trading venues increases the potential for multiple systems to be disrupted if one or more systems malfunction, and there also has been an increase in the percentage of order flow handled and executed by dark trading venues from 25 percent in 2009 to 35 percent.
According to Chair White, the lack of transparency in dark pools is concerning. She mentioned that FINRA’s dissemination of aggregate information on the trading volume of alternative trading systems (“ATSs”) is a useful first step to increase transparency, but ATSs represent less than half of dark venue volume. Chair White said that she supports FINRA in considering an expansion of its trading volume disclosure regime to off-exchange market-makers and other broker-dealers. She also stated that the SEC will be considering whether its own rules, such as the trade-through rule of Reg. NMS, have contributed to excessive fragmentation.
According to Chair White, broker-customer conflicts of interest, and how they are exacerbated or mitigated by the rules of different trading venues, comprise an area of regulatory focus. The cost to a broker for executing in different venues can vary widely, and when such costs (and fees to brokers) are not passed through from brokers to customers, conflicts of interest result. To address these issues, Chair White has asked the SEC staff to prepare a recommendation to the SEC for a rule that would enhance order-routing disclosure beyond those required in Rule 606 of Reg. NMS (“Disclosure of Order Routing Information”). She also has requested that exchanges conduct a comprehensive review of their order types and how they operate in practice in order to formulate appropriate rule changes.
Chair White cited statistics highlighting the decline of domestic companies listed on U.S. exchanges and a reduction in the number of IPOs, particularly smaller companies. She stated that this trend has reduced growth opportunities for U.S. investors, and that the SEC must focus on the needs of smaller companies and their investors. Chair White said that she anticipates the SEC will soon complete its review of the terms of a pilot program to allow wider tick sizes for the stocks of smaller companies, which will help address this problem.
Chair White stated that she expects all of these measures to be considered in the coming months and has recommended that the SEC establish a new Market Structure Advisory Committee to serve as an additional resource and forum in which market participants may review specific initiatives and rule proposals.
It would be an understatement to say that Chair White covered a lot of ground in this speech. Chair White addressed a complete revisit of the self-regulatory-organization structure and reconsideration of Regulation NMS from stem to stern. She also committed to a review of fee structures and order types offered by securities exchanges. Among other significant potential rule changes, Chair White suggested (i) expanded broker-dealer registration requirements to include certain high volume trading firms, (ii) changes in tick sizes for trading in smaller companies, (iii) additional regulatory requirements that might apply to high-frequency or algorithmic trading strategies and (iv) additional reporting requirements that might apply to off-exchange trading venues, not limited to dark pools. Chair White expressed the view (for which there is a great deal of academic support) that today’s high-speed, technology-operated trading markets are far better for investors than was the old manual trading market that was largely dominated by the NYSE. It is notable that Chair White acknowledged that at least some of the problems in today’s markets result from SEC rules that are outdated, or otherwise do not work as intended, rather than from the misconduct of market participants.
Fellow SEC Commissioner Gallagher issued a tweet praising the “great speech” by Chair White. Commissioner Gallagher has been a leading proponent for review of many of the issues raised by Chair White, including a reconsideration of Regulation NMS and equity market structure.
One of the market problems mentioned by Chair White was the diminution of IPOs by small companies. While increasing the tick size for trading in these companies may be helpful, it is likely that the greater discouragement to IPOs comes from the burdens that SEC requirements put on public companies, an issue raised separately by Commissioner Gallagher in another speech reported in today’s news.
