Reforming The Regulation
Jim Toes of the US Security Traders Association discusses the role of public comment in forming US regulation as well as its effects on other asset classes and international markets.
US equity market structure endured criticism in recent years, raising questions about its functionality. Yet, US equity markets remain the most liquid in the world, with the tightest spreads. It would appear, investors do not share the same level of concern as the financial press.
In considering market structure and the role of regulation, a balance must be struck. Regulation should allow market participants to compete among themselves like, one broker dealer with other broker dealers and then, to a certain degree, between themselves like broker dealers competing with other participants for example exchanges.
While the regulator and market participants differ, in that regulators and participants have fundamentally different roles to play, the discussion must move to procedures and policies. It is the responsibility of regulators to be in touch with the marketplace and decide whether more feedback is needed via a review or a concept release, after which, new rules can be introduced with comment periods.
All market participants are able to comment on SEC concepts, releases and rule proposals. Regardless of whether ideas start from public discourse and the SEC takes them into consideration or the SEC pens a proposal and submits it to the public for comments, ideas and the responses they engender, do circulate in a transparent manner.
To facilitate more accurate regulation, the SEC has taken great strides in its ability to capture data through its Market Information Data and Analytics System (MIDAS). The SEC’s Office of Analytics and Research, comments on its interpretation of the data via its website, which enables market participants to comment on the process.
So they have the ability to pull in data through their MIDAS system, they have the ability to interpret it through their department of economists. They’re being transparent in how they are interpreting it and through the website, which is their outreach program to market participants, and which enables people to look and comment.
The SEC’s transparency has reassured traders, and its transparency dramatically increased the SEC’s industry credibility. Increased reliance on data may also encourage regulators to prioritise standardisation of infrastructure to facilitate more efficient supervision.
Similar companies, with similar business models could be expected to think, well, similarly. The proposals from BATS and NYSE, however, appear to disagree on fundamentals, or at least priorities.
HFT has created a virtual exchange where liquidity can flow rapidly from one asset class to another, yet there is a natural friction from pressing different asset class’ trading infrastructures into one model. Now there is pressure amongst the two competitors to homogenise trading infrastructures across assets so liquidity can flow even more easily.
The rise of ETFs as a widespread investment vehicle are an obvious source of this pressure, given their need for electronic access to different assets.
Regulatory harmonisation, a central thrust of financial regulators’ response to the global financial crisis is beginning to lose steam. There was a time when the SEC would make a market structure rule and other countries would replicate it. As markets globalise, however, a number of larger markets are making decisions based upon what they deem best for their participants.
Having said that, liquidity continues to course around the world. Global money flows pressure regulators’ decisions because the wrong decision could very easily see liquidity leave their nation. Traders in far flung jurisdictions depend on their domestic regulators’ tacit cooperation with US counterparts.
FINRA’s Trade Reporting and Compliance Engine in the US obviously had a major impact on fixed income and benefited investors, but market participants need to realise that transparency has a cost. That cost can be explicit, through the operational costs of providing added transparency to investors, or implicit through the way existing participants change their behaviour.
In the next three to five years, non-equity asset classes will go through a review as to how it would work on an equity-style market structure platform. Just as FX went from an over-the-counter market in the 1980s to the equity-style market we have today, the pattern will repeat.