How to Improve Market Structure

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A trader at the New York Stock Exchange on Monday.Credit Lucas Jackson/Reuters
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Curt Bradbury is chief operating officer of Stephens Inc. and chairman of the market structure task force of the board of the Securities Industry and Financial Markets Association, or Sifma. Kenneth E. Bentsen Jr. is president and chief executive of Sifma.

The United States has the deepest and most liquid stock market in the world. Over the last decade, regulation, technological advancements and competition have created an equity market structure that is easier to access and far more affordable for investors, including retail investors. The result is a strong market system that helps Americans achieve financial security and provides companies with access to the capital they need to grow and create jobs.

These same factors that have benefited investors – technology, regulation, and competition – have also led to a market structure that is increasingly complex and fragmented. Much of the focus has been on speed of trading, the product of technological innovation. And while the markets are most certainly not “rigged,” and unquestionably less expensive in terms of commissions and spreads, this complexity and fragmentation has resulted in disparate treatment that is undermining investor trust and confidence. Failure to address declining trust will ultimately undermine the market itself.

The Securities Industry and Financial Markets Association, or Sifma, which represents nearly 400 broker-dealers, banks and asset managers, convened a broad-based task force of our members to develop a series of market structure changes that we believe will enhance transparency, provide for fair and timely access to market data, and address the complexity and fragmentation caused by rebates and order types.

While our proposals address the matter of speed, it is not about speed itself, but rather how investors are served. Further, we propose that regulators should make changes to ensure stability and resiliency in the markets.

Regulation NMS, which went into effect in 2007, requires market participants to send their orders to the market that offers the best public price. This requirement has significantly increased the number of trading venues over the last seven years and led to an equity market system that is extremely fast and highly interconnected. There are more than 10 public exchanges and dozens of off-exchange trading venues in the United States. With so many moving parts, it is important to continuously review market structure to ensure it continues working in the best interest of all investors.

Our recommendations fall under three areas.

First is addressing market complexity and fragmentation.

Access fees charged by exchanges and other venues should be dramatically reduced, if not eliminated. While brokers are legally required to route their orders to the exchange that is quoting the best price – so called “protected quotes” – the exchanges are permitted to charge relatively high fees for accessing these quotes: currently 30 cents for every 100 shares. These fees have distorted market pricing as they are a significant percentage of overall trading costs and are several times higher than the fees charged by off-exchange venues. As a result, brokers often avoid routing their orders to exchanges. Exchanges also rebate most of their access fee revenue through price structures such as “maker/taker.”

These developments have led to a proliferation of order types designed to avoid access fees and capture rebates, and that proliferation, in turn, adds complexity to the system, requires continuing technology changes and creates potential for market instability. The Securities and Exchange Commission should reduce the current cap on access fees to no more than 5 cents per 100 shares, and indeed should consider eliminating access fees altogether.

Regulators should also take steps to reduce the number of trading venues to which a broker dealer must connect and eliminate those that do not add true liquidity to the market. Further, the S.E.C. should review whether certain order types contribute or create activity that should otherwise be discouraged; whether to reduce unnecessary and excessive order traffic; and spur the development of a standardized kill switch mechanism. Together, these changes would reduce the risk of market instability that is inherent in a highly fragmented, complex market system.

Second is promoting fairness in market data dissemination. All users of market data should have access at the same time. Currently, the exchanges own and operate a centralized, public feed of the best market prices through the Securities Information Processors – or S.I.P.s. However, the exchanges sell private, direct data feeds that are not processed through the S.I.P. and therefore are available to subscribers before the S.I.P. feed.

Moving forward, it is important that the market data feeds provided by the S.I.P.s and the direct feeds provided by the exchanges are distributed to all users at the same time. In the short term, the S.E.C. should direct the exchanges to improve the S.I.P.s so that they provide the fastest commercially available services for data aggregation and distribution. In addition, the governance of the S.I.P.s should include direct industry and public participation, and they should provide public disclosure of their operations and performance. Over time, the central S.I.P. structure should be replaced with multiple processors that would distribute public market data and compete on performance and cost to better serve the marketplace.

Third is encouraging robust transparency and disclosure, for both retail and institutional investors. Today’s markets are extremely transparent by rule and practice, but we can do more to help investors understand how their orders are routed and executed. Market participants should provide investors with better disclosure of relevant information in a standard, easily understood format.

For retail investors, brokers should provide public reports of specific order routing statistics and metrics. This information will help retail investors better understand how markets work and enable them to compare performance among brokers, ultimately increasing their confidence in the markets.

Sifma also recommends that brokers provide institutional customers with standardized venue execution analysis reports. At the same time, the S.E.C. should direct the exchanges to provide standardized public disclosure of their trading volumes through undisplayed and partially undisplayed orders.

Bottom line: Increased transparency will increase investor confidence, which is essential to a robust equity market system that can stimulate economic growth in the United States.