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Top Five Takeaways from SIFMA’s 2023 Market Structure Conference

In this episode of The SIFMA podcast, Joe Siedel, SIFMA’s Chief Operating Officer, and colleague Ellen Greene, Managing Director of Equity and Options Market Structure, discuss why the SEC’s rulemaking agenda continues to raise questions. They dive into some of the key questions around the equity market structure proposals and how they may affect listed options and innovation. With the move to T+1 next May, Joe and Ellen also talk about why customer education is a critical component in the transition.

Transcript

Edited for clarity

Joe: We recently hosted our Market Structure Conference in New York with a focus on listed options on Day 1 and equity market structure on Day 2.

In addition to the efforts of SIFMA’s Equity Markets and Trading Committee and the Listed Options Trading Committee, this conference provides a forum to engage and brings together market participants and stakeholders to discuss views on critical issues impacting the market.

Across the ecosystem, we all share the same goal of enhancing the investor experience and ensuring that the markets remain liquid, efficient, fair, and resilient.

Ellen: And, as we heard throughout the discussions, the SEC’s rulemaking agenda continues to be a focal point for the industry and raises questions as well as the need to analyze potential impacts. This podcast will discuss those key concerns. The other four topics that are top of mind among markets participants are:

  • The impact of the Equity Market Structure proposals on options – particularly the Best Execution Rule and the Predictive Data Analytics Proposal
  • Why we should focus on updating Rule 605 first
  • Innovation
  • And moving to a T+1 settlement cycle.

Joe: Thanks for tuning into this episode of SIFMA’s podcast series. I’m Joe Seidel, SIFMA’s Chief Operating Officer. I’m joined by my SIFMA colleague, Ellen Greene, who is Managing Director of Equity and Options Market Structure.

Ellen: Joe, to kick off, can you talk about the SEC’s rule making agenda?

Joe: Sure. With the SEC’s rulemaking agenda, it’s important to note that:

  • Based on the Agency Rule List published by the Office of Management and Budget, the SEC is on track to propose and finalize 63 new rules by the end of Chair Gensler’s first four years in office.
  • Of the number of rules proposed over the last two years, only eight have a specific Congressional mandate.
  • And the proposals to completely overhaul U.S. equity market structure are of particular concern. They do not address market failures, and some seem to contradict each other, prompting the need for a holistic review in our opinion.

Ellen: I’ll take a moment to touch on those proposals:

  • Rule 605, which would update important Order Execution disclosure Information, has not been updated in 20 years
  • Regulation NMS, which includes changes to Tick Sizes, Access Fees, and market data
  • Regulation Best Execution, which is being proposed despite the existence of a FINRA rule
  • The Order Competition Rule, which would introduce mandatory exchange auction for retail orders
  • And the most recent proposal is Volume-Based Transaction Pricing, which would prohibit exchanges from offering volume-based transaction pricing in connection with the execution of agency or riskless principal-related orders in NMS stocks.

Joe, what’s interesting about this most recent proposal is that it is in direct contradiction with the Reg NMS proposal, which includes a component that pertains to volume-based exchange transaction pricing. However, this proposal prohibits exchanges from charging fees that are not determinable at the time of execution since tiered pricing is not calculated until the end of each month. This proposal would require exchanges to modify their fee structures so that volume tiers would be backward-looking, because it is based on volume from a previous period, allowing the fees to be determinable at the time of execution. It’s a real conundrum trying to understand what the SEC is trying to achieve with these two conflicting proposals.

And lastly, the Predictive Data Analytics proposal, which would require firms to eliminate or neutralize technologies that use predictive data analytics. This would limit the ability of firms to use technology to provide valuable information and services to their clients – impacting market efficiency, competition, and investors.

As we think about these proposals, while they’re presumably focused on the equity markets, these proposals will also impact the options market, which is notable given the high volumes and retail and institutional participation in the market.

To give some background, this market offers investors flexibility in terms of strategies offered and provides investors with the tools needed to meet a host of different investment objectives and risk tolerances.

And, while options have been mischaracterized by some recently as a short-term, risky, speculative tool, in reality, the vast majority of investors use options as part of a well-considered strategy to meet their investment objectives. Retail traders are a large part of the robust options volume.

Joe: As an important market that plays a crucial role in investors’ overall trading strategies, it is essential that regulation does not also harm the very investors it is designed to protect. And it remains unclear what impact the Equity Market Structure proposals could have on the options market.

Ellen: It’s a great question. If we were to take the proposed best execution rule, this rule could affect multiple asset classes including options and fixed income.

If we look at the options market, today, many retail options orders are routed to exchange price improvement auctions where they are guaranteed an execution. It is impractical to consider off-exchange pools of liquidity since, unlike the equity markets, all options trading occurs on exchanges.

We are still exploring what finer ticks or reduced access fees could mean for this market, or what a Rule 605 for options might look like. We think it’s critically important to get 605 right for equities and once the implementation has been completed, only then should we turn our focus to listed options.

The bottom line is that the potential cumulative and interactive effects of these proposals are not fully understood and have not been subject to sufficient cost-benefit analysis – raising the question of what problem the SEC is trying to resolve.

Joe: That’s an excellent point, Ellen. We heard throughout the conference the need to update Rule 605 as a natural starting point for the regulatory path forward and why we can’t rush changes to the U.S. financial system.

With all the change that has occurred over two decades, it just makes sense to review what’s in place for the Disclosure of Order Execution Information and update the rule where needed to reflect the reality of today’s markets. And support for this is seen across the industry, in the comment letters sent to the SEC. By amending Rule 605, the SEC will have the current data it needs to fully assess market quality and consider whether additional rulemaking is even necessary.

Ellen: Which is such an important point to consider, Joe. As we think of some of the SEC’s rulemaking, the Predictive Data Analytics Rule is an example of a proposed rule that needs to be examined much more closely. Which brings us to the topic of innovation.

When the industry innovates, costs are reduced, investor access increases and the customer experience improves. Technology has created tremendous benefits for retail investors and has opened up the market to younger and more diverse investors. The Predictive Data Analytics Rule could potentially take that benefit away.

Both of our keynote speakers and the Exchange Leaders panel talked about this impact – especially since it seems that today’s focus is more on regulation and less on innovation.

Tom Sosnoff, our Options keynote speaker who is known for being an innovator and financial educator in the options space, said that we cannot be a closed ecosystem. Ideas and innovation must be welcomed. The future of options relies on exchanges and regulators working together with the brokerage community to ensure that new product introductions make sense for both firms and investors.

Joe: When asked about the proposals, our Equity keynote speaker Congressman Ritchie Torres, talked about the risk of changing too much too soon. He noted how the rise of zero-based commission trading removed market access barriers, enabling more to invest. To change that is to remove opportunities from the individual investor.

The exchange leaders talked about using a data-driven approach and how tech advancements modernize workflows and systems across the board. This is vital to keep capital markets and options markets liquid and healthy.

Lastly, we’re at our fifth takeaway: T+1, the foundational rule which the industry is very focused on and working towards the May 2024 transition date.

Ellen: A key point that was raised is the important reminder to educate retail customers – to make sure they understand what the shorter settlement cycle will mean.

Today, customers have 2 days to make payment after a trade for an equity security–once T+1 is settled firms and investors will need to make sure they have proper procedures in place so that trades can settle on a next-day basis.

Joe: T+1 is a significant effort and an example of how the industry is working together, while also addressing the Consolidated Audit Trail and other myriad regulatory changes. We’ll continue to work to understand how all these changes will affect each other.

For more on these discussions, read the SIFMA Insights Debrief about the 2023 Market Structure Conference in which Katie Kolchin, our head of research, dives deeper. Thanks for listening today and Ellen, thanks for joining me for this discussion.

To learn more about SIFMA and our work to promote effective and resilient capital markets – including comment letters – please visit us at www.sifma.org.  

–

Joseph Seidel is Chief Operating Officer of SIFMA

Ellen Greene is Managing Director, Equity and Options Market Structure at SIFMA.

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