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Securities and Exchange Commission Investor Advisory Committee Meeting

Securities and Exchange Commission (SEC)

“Investor Advisory Committee Meeting”

Thursday, March 28, 2019

 

Discussion Panels

 

Opening Statements

Jay Clayton, SEC Chairman

Clayton said that the areas the SEC is focused on improving are capital disclosures, including human capital, the regulatory structures to stock exchanges, and increasing access and investment to research. Clayton expressed reforming the regulatory framework to meet technology and practical standards, as well as providing transparency in areas such as the alternative trading system (ATS). He said that the Division of Trading and Markets held roundtables on thinly traded securities, retail approaches to combating fraud, and market data and market access. Clayton said the Commission will work for balanced and constructive polices to improve investor confidence, integrity, security and trading protections, human capital scope, disclosure requirement flexibility maturity and efficiency, and fair exchange, fees, and research mechanisms that focus on creating a level playing field and work around Markets in Financial Instruments Directive II (MiFID II) compliance issues.

Commissioner Elad Roisman

Roisman said market structures are liquid and mature and that the Commission will work to ensure they are fair and efficient. He said trade is easier and cheaper, and the tools and information for investors are constantly improving as more safeguards are in place. Roisman said he is committed to working with the Commission to increase evident market data, increases to disclosures including human capital, and continue to reform the regulatory structures for investor protections and continue the trend for investment in research.

Panel I – Stock Exchanges: Investor Protection Under the Modern Exchange Regulatory Structure

Panel Presentations

Ken Bertsch, Executive Director, Council of Institutional Investors, said that for an effective market to work, there should be independent and flexible firms that are not hurt from excess fees and can continue to be profitable while protecting investors. He said exchanges are the gatekeepers of information and maintaining listed company options, and therefore should have fair standards to their listings, especially regarding class stocks. Bertsch said that Hong Kong has played a major role in the dilution of listing standards and should be subject to oversight, and recommended oversight of SEC filings for exchanges and improvement to trading structures with implementation of the SEC transaction pilot fees. Bertsch said investors are “overwhelmingly” in support of this program and the market should not monopolize the access to data for excess profit. He voiced support for Clayton’s idea to consolidate core data, IEX’s release of the cost and usage of data. Bertsch stated that thinly trades shares are a problem and lack the trust of investors, which make them difficult to reform, and the suspension of Unlisted Trading Privileges (UTP) could help address the concerns of illiquid stock fragmentation.

Tal Cohen, Senior VP, U.S. Equities, Nasdaq, said the role of exchanges is to protect investors through dynamic, efficient and well-regulated structures, and that they are vital for job growth and wealth creation, as well as advocates for market surveillance and listing oversight. Cohen recommended developing technology systems that are up to speed and could help detect rule violations and enhance the initial public offerings (IPO) process. He said adopting the Consolidated Audit Trail (CAT) will help reduce false positives in surveillance and further assist in compliance reviews. Cohen had three major recommendations for the Commission: 1) adoption of the intelligent tick sizes; 2) address the one-size fits-all thinly trading of securities structure; and 3) provide a path forward for market data utilization at cost efficient prices. He stated that tick sizes can help increase liquidity and competition and reduce costs through creation of a fair fee and rebate system. Cohen also voiced support for supports the Chairman’s UTP suspension policy and believes market data should come at a price that is reasonable, further recommending reform to the structure of securities information processors (SIPs) and the revenue formula.

Tyler Gellasch, Executive Director, Healthy Markets Association, said the exchanges should be modernized to continue providing access to markets and help execute capital to drive the economy. He said since 1998 exchanges have seen many new adoptions but are still lacking complete safeguards for investors and are focused on profit maximization. Gellasch said it is important for pricing tiers to be established and to remember to treat all models of exchanges and firms as independent. Gellasch said the Securities Exchange Act’s definitions for fees and market place balance is not how exchanges are currently operating and should be reformed to balance the connectivity of data and lower barriers to entry. He also advocated for a reform to the regulatory structure and capital disclosure requirements.

Brad Katsuyama, Co-Founder & CEO, IEX Group Inc., said that exchanges effect many stakeholders on both the buy side and sell side and should not treat investors as second-class citizens. He stated his support for the SEC’s transaction fee pilot and said the application of this program would help provide oversight over corporate interest and protect investors. Katsuyama said standards should be implemented to help investors avoid burdensome competition and fees to create a fairer market place. He said the rebate system should be changed to avoid monopolization to access to market data, as the rebates are not being passed back to investors and increasing their costs to enter and stay informed of their investments. Katsuyama said connectivity and data are becoming less accessible for investors and suggested implementation of the SEC’s pilot program without delay. He also said a two-tiered SIP system to consolidate data would create a more robust structure and help fill in the gap for costs to exchanges. Katsuyama voiced support for the Chairman’s plan to suspend UTPs and said more transparency and disclosure requirements would also benefit the exchanges.

Mehmet Kinak, VP & Global Head of Systematic Trading & Market Structure, T.Rowe Price, said the need for certainty to long term buy side investors is a function that is improving but needs further reform. He advocated for simple and more efficient markets with low barriers to entry. Kinak said the exchanges are lacking modern technology and standards to keep pace globally and domestically to the needs of investors and should be reformed in the regulatory structure and reduce fees and costs to investors. He said the fee pilot program would be something to begin with, as well as reform to overnight policy rates (OPR) to address market free principals at the exchange levels. Kinak said OPRs have reduced the incentive to innovate and established execution standards for brokers to create unfair pricing tiers, hurting small exchanges. He also recommended to reconsider Regulation National Market System (Reg NMS) to provide more investor choice and create a less fragmented exchange structure.

Chester Spatt, Pamela R. and Kenneth B. Dunn Professor of Finance, said the role and governance of self-regulatory organizations (SROs) is for a profit maximizing model and should be considered when making reforms to the regulatory system. He said the maker-taker model is an area for improvement to help increase liquidity in the market and to reform the rebate and fee structure. Spatt said the volume discounts for larger amounts of liquidities has led to price discrimination, adding that the rebate system has caused for investors to see little to no returns and more costs for access to the markets. Spatt recommended the Commission focus on broker obligations to remove these fees and reform to rebates to incentivize a path for increasing liquidity. He said the pricing schedule should be less complicated for exchanges and pricing tiers should have changes to their pricing limits. Spatt also recommended changes to disclosure formulas to help investors better access information and make more informed decisions, rather than being disadvantaged.

Panel II: Trends in Investment Research and Potential Regulatory Implications

Panel Presentations

Nanette Buziak, Managing Director, Head of Equity Trading, Voya Investment Management, said reforms should be implemented to benefit mid- to small-cap management firms to increase corporate access for analysts to have proper research. She said the Bull and Bear model requests, macro strategy thoughts, and market research help investors make better decisions. Buziak stated that research is vital for model requests and data mining and helps for effective and best execution practices. She mentioned the market transition to passive bench marks has led to alphas collecting fees in this approach. Buziak said active investors care about research, such as corporate filings and mergers and acquisitions, and as profit and loss (P&L) money spending increases, research usage is declining. She expressed three concerns: 1) the growing scarcity of research coverage for capital formation for small-cap firms; 2) MiFID II costs to entry leading to dark information for investors; and 3) forced relationships caused by MiFID II cutting down on research access and sharing of information. She voiced support for investor protections and pushed for the SEC’s Regulation Best Interest (Reg BI) rule to be implemented.

William Llamas, Director, Relationship Manager, Greenwich Associates, said research has shown effects from MiFID II on buy side relationships as research budgeting, firm employment for research, mechanism for tracking, and broker dealer payouts have seen major changes. He said the research shows lots of uncertainty and increases to costs in Europe and have led to many U.S. firms waiting to see effects from MiFID II. Llamas said firm employment for research and research budgets have both seen a 20 percent decrease, with P&L seeing the biggest declines for mid- and small-cap firms. Llamas said the unintended consequences have been passed on to buy side firms and led them to make these drastic changes to condense their broker research lists. He said the effects have started to level off, but MiFID II burdens have caused a back and forth process for the relationship on the buy and sell side for market research. Llamas said buy side broker employment has seen cuts, while maintaining the same deliverable output, in order to cut wasted costs to many firms under MiFID II. He said MFID II will have good and bad policies for U.S. firms, but will largely impact smaller firms who have more regulatory and legal obligations that they will not be able to meet.

Amy McGarrity, CIO, Colorado Public Employees’ Retirement Association, said sell side and external research is important for equity firms, as asset owners use and will only pay for information they deem beneficial. McGarrity said managers should be able to pay separately for execution costs and use this sell side information for making more efficient decisions. She continued that bundled sell side information is not transparent and adds unnecessary costs to firms for irrelevant research. McGarrity said there should be a limitation on broker selection costs for highly traded commission rates and minimized trading volumes for bundles information. She said unbundling is very positive and provides firm negotiations and disclosures of research in advance to the sales. She said the U.S. is at a disadvantage without MiFID II’s transparency standards, as external equity managers have more exposure to their clients and unbundling opportunities to cut operational costs. McGarrity said U.S. asset owners have higher execution rates than Europe, while both regions have equitable access to beneficial information. She said without MiFID II, U.S. investors are at an unnecessary disadvantage because of less than optimal tradeoffs.

Question & Answer

When asked about the forced relationship of issuers leading to unnecessary research being bought is appropriate and difficulties proposed by MiFID II in research sales, McGarrity said she has not seen drop-off since MiFID II implementation, and that corporate access of sell side research access has not declined in any way

In response to a question on whether the size of issuers has led to the decline in data usage and sales, Llamas said there is no dynamic evidence yet of such a break down.

When asked about the independence of sell side management and if all brokers are providing beneficial coverage to investors, Buziak said the sell side purchases research based on benefits and pay after it proves to be useful in the current system. She said this seems to be changing and causing less allocation of budgets toward research. McGarrity said the investor drives the alpha for research through creating differentiated viewpoints.

In response to a question about where active management fits in to the market and how quantitative strategies are affecting asset managers, McGarrity said that active money has decreased, and passive money is growing. Llamas said that as consumer research remains steady, there is a distinction to the type of research used, as the push is for quantitative strategies for cost efficient employment. Buziak said there is a big shift in liquidity in the markets, as with passive money and more stock buybacks, liquidity is decreasing.

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