A blue-ribbon panel is proposing a bevy of reforms that it hopes will restore confidence in the stock market.
Responding to charges of a “rigged” market and propelled by some highly publicized malfunctions, the Committee on Capital Markets Regulation released a laundry list Thursday of changes it believes will make the market function better.
“Flash Boys” author Michael Lewis famously made the “rigged” accusation following the 2014 publication of his book that detailed the crusade of upstart exchange IEX to counter high-frequency trading strategies. HFTs use computers to trade in milliseconds. They’ve often been faulted for market problems, with the book detailing the measures HFTs go through to gain advantages over competitors.
The committee said it does not believe Lewis’ claim is accurate, but acknowledged the market is in need of some basic structural reforms.
“Although our markets are not rigged, there is clearly room for improvement,” Hal Scott, a renowned Harvard professor who chaired the committee, wrote in an essay that accompanied the 180-page report. “And our blueprint provides the SEC with the direction that it needs to unleash the benefits of a resilient, transparent and competitive stock market.”
The panel consisted of executives across Wall Street. Members include hedge fund titan Ken Griffin at Citadel, Kenneth Bentsen Jr., who heads the Securities Industry and Financial Markets Association, and multiple representatives of trading firms and Wall Street investment banks.
Recommendations were designed to address three broad issues: increasing transparency so investors have a clearer idea of what’s happening in the market with regard to pricing; “strengthening resiliency” so that damage from episodes like the March 2010 “Flash Crash” and the Aug. 24, 2015 event where half the S&P 500 stocks didn’t open on time is minimized; and reducing transactions costs.
Among the proposals: Increased disclosure on trading activities, quicker triggering of “circuit breakers” that halt trading during unusual activity, and a top-to-bottom review of fees and pricing.
One recommendation in particular, that exchanges be forced to reduce the fees they charge brokers, would save investors $850 million a year, the report said.
Scott specifically said the changes were inspired by “Flash Boys” and follow some recommendations made by IEX.
However, he also said some of the concerns about the market are misplaced.
For instance, Scott said strategies employed by high-frequency traders, such as trying to capitalize on discrepancies in price spreads for individual stocks, “are just modern versions of traditional market making and arbitrage strategies that have always existed and provide important benefits to investors.”
The report also said that “dark pools,” or trading venues operated away from public exchanges, actually help save investors money through better pricing.
“We find that even during times of crisis there is limited empirical evidence that HFT strategies contribute to price declines, with the majority of studies finding that HFT strategies help stabilize prices during a market crash,” the report said.
The authors said most of the recommended changes can be implemented by the Securities and Exchange Commission, though a few will require legislative action.
The complete list of proposed changes:
(1) Increasing the Transparency of our Equity Markets
1. The SEC should require that disclosures on new Form ATS-N are published in a standardized format. (The form requires detailed information about dark pool operators.)
2. Required disclosures of registered exchanges should be revised to include trading volumes attributable to undisplayed (“dark”) order flow.
3. Retail brokerages should be required to provide disclosures regarding execution quality for their customers. Relevant disclosures should include percent of shares with price improvement, effective/quoted spread ratio, and average price improvement.
4. The SEC should require broker-dealers to provide institutional customers with standardized reports that provide order routing and execution quality statistics.
5. Trading venue disclosures should include information about execution speeds to the millisecond.
6. Statistical information for disclosures pursuant to Rule 605 and Rule 606 and disclosures regarding institutional orders should be submitted in only one format to facilitate comparison across trading venues and among broker-dealers.
7. The SEC’s cost benefit analysis for the Consolidated Audit Trail did not determine whether the $2 billion in implementation costs and $1.5 billion in annual reporting costs for broker-dealers would be passed on to investors. Prior to finalizing the CAT, the SEC should conduct a publicly available analysis that evaluates the costs and benefits of the CAT, and applies the cost benefit analysis to ensure that the CAT is implemented efficiently, with costs allocated appropriately amongst the stakeholders.
8. The SEC should pass a rule applying the order protection rule to odd lot transactions above a threshold dollar amount, instead of a threshold share amount.
9. Broker-dealers should be required to disclose how access fees and liquidity rebates affect order routing practices and transaction costs for their customers.
10. The SEC should require exchanges to publicly disclose revenues from the securities information processors (“SIPs”), the allocation of market data revenues among SIP Plan Participants and revenues from proprietary data feeds.
11. The SEC should require exchanges to disclose performance data for the SIPs and proprietary data feeds to facilitate a comparison of the relative speeds with which investors can obtain actionable market data from each.
(2) Strengthening the Resiliency of our Equity Markets
1. Thresholds for market-wide circuit breakers should be adjusted so that they are triggered when a pre-determined number of stocks or percentage of an index display extreme volatility by triggering their individual trading halts.
2. The SEC and the Commodity Futures Trading Commission should work together to harmonize the thresholds for market-wide circuit breakers in the stock market with the futures market.
3. The SEC should establish uniform Limit Up-Limit Down (“LULD”) intraday price bands, instead of wider bands during the market open and close.
4. The SEC should eliminate clearly erroneous trade guidelines by aligning them with the thresholds for LULD rules.
5. The SEC should require mandatory kill switches on all exchanges for all exchange members.
6. The SEC should clarify exchange regulatory trading halt procedures in the event of specific operational failures (e.g., SIP failure).
(3) Reducing Transaction Costs by Enhancing Competition
1. The surveillance and enforcement regulatory responsibilities currently assigned to (Self-Regulatory Organizations) should be centralized to the extent practicable. The reorganization could include centralization at either the SEC or FINRA.
2. The NMS Plan process should be revised so that exchange SROs do not have outsize influence in the rulemaking process. Representatives of exchanges, broker-dealers and investors should be permitted to vote on any NMS Plans.
3. Once SRO surveillance and enforcement responsibilities have been centralized to the extent practicable, Congress should revisit the Exchange Act to reconsider exchange legal immunity. Exchange legal immunity should only be available for exchange regulatory functions unique to exchanges that cannot be effectively centralized.
4. The SEC should implement a pilot program to evaluate the impact of a reduction in access fees and liquidity rebates on market quality and trading behavior. The structure of the pilot should generally conform to the framework proposed by the Equity Market Structure Advisory Committee Regulation NMS Subcommittee and leverage existing pilots as appropriate.
5. After concluding the access fee pilot, the SEC should conduct a pilot program for reducing the tick size for highly liquid stocks. The pilot should include a control group and should not include a trade-at rule.
6. After requiring disclosure of exchange market data revenues, the SEC should adopt a “Competing Consolidator” model for data dissemination. As a first step to implementing this framework, the SEC should promote reforms in the governance and transparency of the current SIPs.
7. The SEC should not implement a trade-at rule, as it could increase investor transaction costs without appreciably improving market quality.
8. ATSs should be allowed to limit access to their trading venues.
9. ATSs should not be required to obtain pre-approval from the SEC before adopting trading rules.
