A white paper published by US agency brokerage JonesTrading has launched a scathing attack on the evolution of equity market structure, claiming new pricing models have eroded investor confidence over the past two decades.
The damning report suggests the hunt for flow has led to a shift in focus away from the best interests of clients, evidenced by the growth in structures like the maker-taker model for equities and the rise in high-frequency trading (HFT). The core idea behind the paper highlights the divergence between what regulators have allowed as opposed to what constitutes best practice, and concludes the imbedding of the former above the latter in market rules has hurt investors by complicating the trading system.
The report advises US market regulator the Securities and Exchange Commission (SEC) to take stock of who benefits from current price structures and consider reforms that restore the interests of investors.
Between the crosshairs is the maker-taker model, which the paper claimed has made liquidity the most important factor of trading since its inception in 1997, rewarding those who provide it while relegating the interests of the end investor.
“The intense competition in these models again focuses on the securing of high volume of flow without concern for investor intent,” the report reads, adding that the commodification of data has also negatively skewed markets.
“In today’s fragmented markets, capturing flow is king, in part driven by the need to generate data, which can then be monetised to offset any losses from the maker-taker pricing,” it states.
The document also takes a comprehensive look at American market shifts from 1975, with the end of fixed commissions, through the 1980s, where regulatory focus turns from brokerage fees to liquidity flow, concluding with the negative impacts brought about by HFT and artificial intelligence.
The report labels HFT as opportunistic trading under the guise of market maker activity, which it considered a misnomer because the abundance of orders across multiple venues only creates perceived liquidity, which ultimately hinders traditional investors.
“HFTs bear no responsibility other than to their own algorithms. They have no requirement to meet investor needs or to stand for market stability and provide liquidity to sustain fair, liquid and orderly markets either in counterparty trading or large event driven macro situations,” the report states.
While no concrete recommendations are listed, the report ends by stating artificial intelligence will not live up to its billing as the future of trading, but instead said that the need for increasing integrity in markets would reinvigorate confidence and help to further develop stability in equity trading.