Sell-side criticism of Nasdaq OMX’s plans to offer benchmark algorithmic strategies has opened up another front in the schism between US brokers and bourses on the latter’s status as self-regulatory organisations (SROs).
Responding to a consultation by the Securities and Exchange Commission (SEC) on whether to allow exchange group Nasdaq OMX to offer algo strategies for use on its New York-based exchange, the Securities Industry and Financial Markets Association, said the proposal “raises issues about the roles and obligations of exchanges and broker-dealers in today’s equity market structure”.
In May, Eric Noll, executive vice president, transaction services, US and UK, Nasdaq OMX, unveiled plans for the bourse to offer US members VWAP, TWAP and percentage of volume algorithmic strategies via new order types.
Such execution strategies aim to target a defined price benchmark over a specific period, and are widely offered to institutional investors by their broking counterparts.
To use the service, brokers would first send parent orders to Nasdaq OMX specifying the relevant parameters and strategy. The exchange would then send the orders to a third-party provider for splitting into child orders for algo execution.
But rather than go toe-to-toe with bulge-bracket brokers that have long offered algo trading tools, Noll said Nasdaq OMX’s offering would target mid-tier brokers.
“This is not intended to compete with the high-end, highly sophisticated algo providers, but is instead addressed to the largest part of the market… and says, ‘we can do this for you better, faster, cheaper than you can do it for yourself,’” he said.
Among SIFMA’s concerns is the regulatory advantage Nasdaq’s offering may have over brokers that offer similar algorithmic strategies.
For example, the SEC’s ban on accessing markets without pre-trade risk controls may not apply to Nasdaq in the same way as it does for broker-dealers, which could give the exchange an unfair advantage.
“Regulatory immunity”
SIFMA also took issue with Nasdaq describing the launch of benchmark orders as a “functional offering” that would be provided to members as part of the bourse’s obligations and responsibilities as a SRO.
“This description raises another set of concerns about an exchange’s attempt to characterise its market functions as regulatory functions so that it can claim regulatory immunity for a commercial offering,” stated SIFMA’s comment letter, adding that it was concerned that Nasdaq may use its SRO role to seek immunity from any technology errors associated with benchmark orders.
Despite SIFMA’s criticisms, no broker contacted by The TRADE USA was willing to comment on the matter.
The potential for errant algo trades to cause havoc with markets has gained increased attention over recent months following a glitch that almost wiped out market maker Knight Capital in August.
US exchanges’ SRO status allows them to establish standards that prevent fraud and market manipulation take action against members who violate federal securities law. It also allows them to collaborate and establish rules, such as the consolidated audit trail that US markets are in the process of developing.
The regulatory structure for exchanges came under fire following Nasdaq OMX’s handling of the compensation offered to members as part of the Facebook IPO debacle in May.
The social media network’s listing debut was marred by technical issues at Nasdaq OMX, which delayed the IPO by around 20 minutes and left investors unsure of their exposure. Nasdaq was forced to eliminate trading fee discounts as part of revisions to its compensation package after coming under fire from brokers and rival exchanges.
Fiddling while New York burns?
However, not all have been as critical on Nasdaq’s plan.
Some brokers have highlighted that the use of benchmark strategies like VWAP and TWAP is declining among buy-side institutions as the use of more sophisticated benchmarks like implementation shortfall gain popularity.
James Angel, associate professor of finance at Georgetown University – the only other person so far to register a comment with the SEC on Nasdaq’s plan – stated: “The lack of any publicly expressed opposition is a strong sign that nobody feels that this proposal is unfair to them.
“This proceeding is an example of the SEC staff fiddling while our capital markets burn,” said Angel, emphasising that the regulator had missed a number of congressionally mandated deadlines on JOBS Act and Dodd-Frank rule making.
Angel added that the types of strategies Nasdaq plans to offer represent a reliable and mature technology and that the exchange’s plan to use an outside firm to handle the orders posed minimal technological risk.
Market participants will now wait to see if Nasdaq OMX responds to any of the comments made in the comment letters before the exchange moves forward with its plan.