The investing community has benefited from technological advances such as the rise of innovative trading venues and platforms, high frequency trading and other algorithmic trading, and off-exchange trading / non-displayed liquidity pools. Competition and innovation have driven this growth and, as a result, the markets have generally seen lower transaction fees and costs, tighter bid/ask spreads and more efficient price discovery with greater trading choices for investors.
Algorithmic and High Frequency Trading
HFT is a result of technological innovation and advancement in the financial services industry. High frequency traders use computer programs and algorithms to identify the best available options on a millisecond basis. There has been growing concern that such traders have unfair advantages over the typical investor and are creating a two-tiered market in the equities world.
HFT provides significant liquidity to all kinds of investors, including retail investors and long-term investors. Certain trading strategies associated with HFT have actually helped bring prices in line by identifying and capitalizing on disparities between financial instruments in different markets, thus facilitating better and more efficient prices.
The Role of SROs
In today's markets, securities exchanges and broker-dealer trading venues perform essentially identical functions. Nonetheless, the status of exchanges as self-regulatory organizations (SROs) has not changed, even as the exchanges have evolved from member-owned utilities to for-profit businesses, as well as active competitors with their broker-dealer members. SEC Commissioner Dan Gallagher has indicated his preference for a holistic review of the role of the exchanges as SROs and the regulatory apparatus that governs them.
With a rapidly evolving and complex marketplace, adequate controls are needed to reinforce participants’ trust and confidence and protect against any disruption that may have a systemic impact on the underlying markets. SIFMA supports the proposal and implementation of initiatives that are designed to limit destabilizing price moves in the financial markets, ensure the integrity and security of the underlying automated trading systems, and provide regulators with the proper tools to effectively oversee our markets. Recently implemented and proposed initiatives include the revised Market-Wide Circuit Breakers, the Limit Up-Limit Down Mechanism, Large Trader, the Consolidated Audit Trail (CAT), and Regulation Systems Compliance and Integrity (Reg. SCI).
Market-Wide Circuit Breakers
While market-wide circuit breakers have been in existence for some time, their parameters have been revised to reflect today’s high-speed electronic markets. Unlike the Limit Up-Limit Down mechanism which could halt trading in a individual stock, the market-wide circuit breakers provide for specified trading halts following market declines if the S&P 500 should fall by 7%, 13%, or 20% in a normal trading day.
Sponsored market access refers to when a broker-dealer that is a member of an exchange/other trading platform gives market participants direct access to that exchange/market center. Concern had been raised that without appropriate trade controls and risk management procedures in place, erroneous trades and other market disruptions may be more likely to occur with this practice. As a result, the Market Access Rule (Rule 15c3-5) prohibits broker-dealers from providing customers with “unfiltered” or “naked” access to an exchange or alternative trading system (ATS). Further, the rule requires broker-dealers with market access, including those who sponsor customers’ access to an exchange or ATS, to put into place risk management controls and supervisory procedures that are reasonably designed to help prevent erroneous orders, ensure compliance with regulatory requirements, and enforce pre-set credit or capital thresholds.
See Also: Other Initiatives and Issues
SIFMA believes robust competition and innovation are hallmarks of the U.S. equity markets. Regulation should encourage fair competition among broker-dealers and among markets because such competition inevitably leads to greater choices for investors, which facilitates efficient pricing and best execution.
In July 2014, SIFMA published Recommendations for Enhancing Fairness, Stability and Transparency in the U.S. Equity Markets. The Recommendations are a set of tangible and actionable market structure reforms developed by a broad-based task force of members from across the country and across the industry, including retail and institutional dealers and asset managers. They are designed to promote fair and timely access to market data, address the complexity and fragmentation caused by the current order system, and enhance transparency for retail and institutional investors.
Regulation should not ease competitive pressures and therefore reward market participants who have not kept pace with market developments. The pressure to perform efficiently and effectively in the marketplace will bolster market development, promote innovation and provide U.S. markets and investors with the tools necessary to compete in a global marketplace.
SIFMA supports periodic reviews of our market structure and related regulations to ensure the U.S. equity markets remain efficient, viable and fair for all investors, as well as the review of High Frequency Trading (HFT). We recommend that any regulatory initiatives be tailored to the specific activity and not be generalized across all market participants (in order to avoid unintended consequences such as weakened market competition, information flow/speed, and overall market vibrancy). SIFMA also believes that any regulations must not disadvantage our markets and U.S. investors in the global marketplace, but that there may be a need for greater disclosure about HFT activities and how they affect the markets.
SIFMA supports a holistic review of U.S. equity market structure to ensure safe, sound and efficient markets that investors can have confidence in. A part of that review should focus on the structure of securities exchanges as self-regulatory organizations (SROs).
SIFMA supports the SEC’s overall objective of creating an infrastructure that would provide complete and timely data to regulators in order to assist them in comprehensively monitoring the markets. SIFMA believes, however, that the SEC’s large trader reporting proposal should be considered alongside the Commission’s proposal to create a Consolidated Audit Trail (CAT). The proposed large trader reporting platform plus CAT will likely enhance the SEC’s and regulators’ capabilities to reconstruct market trading activity when needed in the future. SIFMA believes that an efficient, harmonized and market-wide regulatory CAT would be a significant step in improving oversight of the markets.