Judgement day approaches for Reg NMS

Six years after implementation, Reg NMS's days may be numbered, with the Securities and Exchange Commission planning a wholesale review of US equity market structure and a respected analyst calling for market participants to make their views known.

Six years after implementation, Reg NMS’s days may be numbered, with the Securities and Exchange Commission (SEC) planning a wholesale review of US equity market structure and a respected analyst calling for market participants to make their views known.

At a roundtable event on Monday, SEC commissioner Daniel Gallagher said Mary Jo White, the watchdog’s CEO, had backed a broad initiative to review the US equity market.

While no details have been discussed, asserted Gallagher, Reg NMS would be set firmly in the sights of any widespread review of market structure issues, and could be subject to restructuring or complete removal.

In October, Gallagher said a wide-ranging review of US equity markets was needed and suggested the self-regulatory status of US exchanges should be re-thought.

And in a report published yesterday, Larry Tabb, founder and CEO of consultancy TABB Group, said Reg NMS had divided market participants and altered the core functions of US equity markets.

In ‘Regulation NMS Part 1: Loved or Loathed and Why Many Want It to Die’, Tabb asserts that Reg NMS has sparked unintended consequences and driven widespread technological change. As such, he contends, the industry must decide whether to keep, tweak or scrap the regulation.

Following its introduction in 10 July 2007, Tabb says, Reg NMS spurred a technology arms race that has increased execution complexity and championed speed over liquidity. Speaking to theTRADEnews.com, Tabb said the trade-through rule has had the biggest impact. Trade-through rules were created to ensure the best-priced bid or offer was executed before a lesser-priced order, but many argue it has given rise to overly complex markets.

“The trade-through rule and trade-through protection have forced the markets into a unified structure that pushes the market towards high-frequency,” Tabb said. “It also forces the creation of new order types that are confusing and challenging.”

Tabb suggests those who have benefitted from Reg NMS have been the adaptable firms with vast technological resources, including but not limited to high-frequency trading (HFT) firms. Tabb sees the negative impacts of HFT as outweighed by beneficial liquidity provision, but said incentives should be considered for increasing HFT activity in illiquid stocks.

According to the TABB Group, HFT revenue has actually decreased since a 2009 peak of US$7.2 billion, and the firm predicts revenue will total only US$1.1 billion for 2013.

The report also explores the impact of Reg NMS on dark pools. While SEC’s 1997 Regulation Alternative Trading Systems defined the rules for dark pools, Reg NMS indirectly supported their growth by limiting sub-penny spreads to stocks under US$1 in value.

“Many market participants see a penny spread as too wide, so many shares trade in the dark. Combined with the maker-taker fee structure, there is a large amount of flow going to dark pools that could be on exchange,” Tabb said.

The SEC is unlikely to abolish the maker-taker pricing model as European policy-makers have mooted in initial versions of MiFID II, but Tabb believes such a move may well have a positive effect on the market.

The TABB Group will release a follow up report on Reg NMS ‘Plugging the Gaps: Where You Stand Depends Upon Where You Sit’.

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