SEC readies next phase of market structure reform

US Securities and Exchange Commission chair Mary Jo White plans to keep the industry busy thinking about and implementing some of the dozen or so new and on-going initiatives that she announced last week.

US Securities and Exchange Commission (SEC) chair Mary Jo White plans to keep the industry busy thinking about and implementing some of the dozen or so new and on-going initiatives that she announced last week. 

“Addressing the issues of our current market structure demands a continuous and comprehensive review that integrates targeted enhancements with an expansive consideration of broader changes,” said chair White at the time. “But we must not ignore the largely positive evidence of market quality. That reality demands careful study and deliberate action when considering fundamental changes.”

The majority of the initiatives cited by chair White include requests for the SEC staff to develop numerous rule recommendations as well as asking exchanges and the Financial Industry Regulatory Authority (FINRA) to review policies and procedures to reduce systemic risk, increase market transparency and level the playing field for all investors.

However, she first called for the establishment of a Market Structure Advisory Committee, which would consist of industry experts who would review specific initiatives and rule proposals regarding to any planned change to the US equities and options markets.

Improving Market Data

Amongst chair White’s plans are improvements to the delivery and content of the consolidated market data feeds.

One of the first changes she expects to see by the end of June is a new “hot-warm” platform architecture adopted by the securities information processors (SIPs), those who aggregate the individual market data feeds from the US equities exchanges into the consolidated market data feeds. The new design enables SIPs to switch over to secondary systems within 10 minutes if the primary systems fail.

Such designs would prevent extended trading disruptions like that senn on 22 August 2013 when a technical issue at the SIP responsible for Nasdaq OMX-listed securities cause a three-hour mid-day trading halt in those securities. 

Chair White also requested that exchange operators and FINRA investigate adding a time stamp to the consolidated feed, which might include the time the individual exchanges processed or executed a trade. Investors could use this new information to better monitor the latency of the consolidated feeds and determine their usefulness, she suggested.

The proposals likely will have legs, according to Richard Repetto, a principal at Sandler O’Neill & Partners “There’s just too much controversy between the SIP and proprietary data feeds. I don’t think we necessarily return to the old intermarket trading system but we improve the SIP to the point where the performance debate of it versus proprietary feeds is reduced,” he said, referring to the legacy network that connected all US equities exchanges prior to the introduction of Regulation NMS in 2007.

The SEC does not want to issue prescriptive regulations on issues best determined by the market itself, such as the optimal trading speed for the market, according to White. 

“[But, we] would be receptive to a more flexible and competitive trading model that exchanges could adopt,” she said. “These could include frequent batch auctions or other mechanisms designed to minimise speed advantages,” she added. “Or they also could include negative trading obligations for high-frequency trading firms that employ the fastest, most sophisticated tools.”

Beside incorporating additional time stamps into the consolidated market data feeds, chair White also suggests that FINRA extend its recently launched trading-volume reports for alternative trading systems (ATS) to include the trading volumes of off-exchange market makers and broker-dealer platforms, citing that ATSs are responsible for less than half of the non-displayed trading volume.

Not all of chair White’s proposals are aimed at the exchanges and FINRA. She has asked SEC staff to develop a rule recommendation that would expand Regulation NMS’ Rule 606, which requires disclosure of a broker-dealer’s order-routing practice, to include the larger orders typically made by institutional investors.

“The rule proposal would address this gap by requiring disclosure of the customer-specific information that a broker is expected to provide to each institutional customer on request,” she explained. “While some brokers already voluntarily provide some of this information, a rule is necessary to ensure that the disclosed information is useful, reliable, and uniformly available on request to all institutional customers.”

Neither disclosure proposal likely will earn a dramatic amount of pushback from the industry, said Repetto. “Probably applying Rule 606 disclosures will take more work on the part of brokers but there’s an ever increasing trend of transparency, which would be accomplished by this directive,” he explains. “Off exchange trading volumes, I don’t believe, should get much pushback from the industry for the same reason of increased transparency and the importance the marketplace and regulators are putting on it.”

Leveling the playing field

The remaining initiatives consist of additional requests to SEC staff to develop rule recommendations that would reduce the performance imbalance between proprietary trading firms using high-frequency trading (HFT) and algorithmic trading strategies and other investors.

One of the proposals seek to develop an anti-disruptive trading rule “that would be carefully tailored to apply to active proprietary traders in short time periods when liquidity is most vulnerable and risk of price disruption caused by aggressive short-term trading strategies is the highest,” said chair White.

Additionally, she suggests that unregistered proprietary traders be subjected to the same rules as dealers that trade off-exchange. “Dealer membership would significantly strengthen regulatory oversight.”

“Hopefully it would cause less predatory HFT behavior by closer oversight/registration of proprietary traders, reduce the risk of problematic algorithms, and make order types simpler,” added Repetto.

Chair White also would like to see rule recommendations that would improve a firm’s risk management of trading algorithms. 

“The SEC should not roll back the technology clock or prohibit algorithmic trading, but we are assessing the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them,” she said.