Abstract
When Bob Schwartz asked me to speak here today, he provided me this wonderful bully pulpit, along with his permission to choose any topic under the market structure sun. So I thought about what we struggle with most today. Much of that is part of the overall struggle with market structure and the tension that naturally occurs in markets. Somebody earlier this morning said that markets naturally want to come together and that networks want to come together too. That is true.
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Notes
- 1.
See the Securities Exchange Act of 1934 and Regulation National Market System (NMS) for context. The Securities Exchange Act of 1934 is the federal legislation launched on June 4, 1975, to amend the Securities Exchange Act of 1934. The 1975 amendments instructed the Securities and Exchange Commission to cooperate with the industry in creating a National Market System along with an ambitious system for the clearance and settlement of securities transactions nationwide. The amendments also provided for the prohibition of fixed-commission rates, promulgated earlier by the SEC in its Rule 19b-3.
Reg NMS (Regulation National Market System) was adopted by the Securities and Exchange Commission in 2005 and introduced 2 years later to further advance the ideals of a national market system. The regulation includes the order protection or trade-through rule, access rule (fair access) to market data including quotations, and rules on sub-penny trading and on market data.
- 2.
Donaldson, Lufkin & Jenrette (DLJ) was the US investment bank founded by William H. Donaldson, Richard Jenrette, and Dan Lufkin in 1959 and later acquired by Credit Suisse.
- 3.
In a competitive program to encourage trading on exchanges, maker-taker fees offer a transaction rebate to trading participants who provide liquidity and a charge to customers who take liquidity.
- 4.
Compensation and benefit paid to brokerages for sending their orders to different venues for execution.
See Payment for Order Flow. Professionals Pay to Make Trades for Small Investors. Annie Massa, May 20, 2016, Bloomberg. www.bloomberg.com/quicktake/payment-for-order-flow
- 5.
Under US securities law, brokers are required obtain the best execution reasonably available for customer orders. See Best Execution, www.sec.gov/answers/bestex.htm
- 6.
At the time of the conference, exchanges had been lobbying the Securities and Exchange Commission to introduce a rule that would force equities transactions onto so-called lit exchanges unless dark pools, or internalizing matching engines, could show that reasonable price improvement had been achieved (unlike the lit markets, dark pools do not display prices to investors).
- 7.
A trade-through occurs when a stock market order is not executed at the best possible price based on quoted prices at other exchanges. More specifically, the trade-through was enshrined by Securities and Exchange Commission when it enacted Reg NMS (National Market System) in 2005: “A trade-through occurs when one trading center executes an order at a price that is inferior to the price of a protected quotation, often representing an investor limit order, displayed by another trading center,” the SEC explained.
- 8.
See Dark Pools: Fear of the Dark. Third Way. Lauren Oppenheimer, John Vahey. August 28, 2013. http://www.thirdway.org/report/dark-pools-fear-of-the-dark
As the authors explain: “Dark pools are private, electronic stock trading venues that allow buyers and sellers of a stock to be matched anonymously. In a dark pool, prices are not displayed to investors—stock prices are dark. Dark trading is an alternative to trading on a ‘lit’ exchange, like the New York Stock Exchange (NYSE), where traders benefit from visible prices.”
- 9.
The Consolidated Audit Trail, aimed at tracking the life cycle of all stock and options orders, was approved by the Securities and Exchange Commission on November 15, 2016, a system with a reported price tag of $2.4 billion.
See SEC Approves Plan to Create Consolidated Audit Trail. https://www.sec.gov/news/pressrelease/2016-240.html.
SEC Approves Consolidated Audit Trail to Detect Market Manipulation. Audit trail to track life cycle of every trade in U.S. market. David Michaels, Wall Street Journal, November 15, 2016. http://www.wsj.com/articles/sec-to-vote-on-consolidated-audit-trail-to-detect-market-manipulation-1479240411
- 10.
Long-Term Capital Management L.P. was a hedge fund management firm in Greenwich, CT., employing absolute-return trading strategies along with high financial leverage. The firm’s Long-Term Capital Portfolio L.P. collapsed in the late 1990s and was bailed out in 1998 under Federal Reserve Supervision.
- 11.
The NBBO, National Best Bid and Offer. In simple terms, the National Best Bid and Offer requires brokers under US regulation to guarantee that customers receive the best prevailing ask price when they buy securities and the best prevailing bid price when they sell.
The Code of Federal Regulations explains: “National best bid and national best offer means, with respect to quotations for an NMS Security, the best bid and best offer for such security that are calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan.”
- 12.
Larry Tabb, writing in the Tabb Forum in December 2016, notes the concept of the consolidated/aggregated market data feed in the US equities markets.
Tabb explains: “Data for the consolidated feed is published by the various exchanges, aggregated by the Securities Information Processors (SIPs), and then distributed to the SIPs’ subscribers (either directly or through market data providers). The consolidated feeds historically are slower than exchange direct feeds. While the SIPs have been working on accelerating aggregated data feeds, the process of significantly improving SIP latencies and robustness shifted into overdrive after the August 2013 SIP outage that closed the US equity markets for 3 h. Many market participants believe that if we can reduce SIP latency, it will reduce latency arbitrage and create a fairer and more efficient market. While this is true, eliminating direct feed/SIP latency arbitrage is more complicated than just speeding up the SIP.”
SIP defined: “The Security Information Processor (SIP) links the US markets by processing and consolidating all protected bid/ask quotes and trades from every trading venue into a single, easily consumed data feed.” Source: Consolidated Tape Association.
More broadly, the NYSE and NASDAQ, at time of writing, each operated a SIP for US stock exchanges, the former showing the best bid and offer for NYSE-listed stocks and the latter showing the NBBO for NASDAQ stocks. These data processors consolidate quote and trade data for stocks listed on their exchanges. The data is then disseminated for a fee to investors, market-data providers, and others. NYSE also operated a SIP for options exchanges.
- 13.
Reg NMS (Regulation National Market System) was adopted by the Securities and Exchange Commission in 2005 and introduced 2 years later to further advance the ideals of a national market system. The regulation includes the order protection or trade-through rule, access rule (fair access) to market data including quotations, and rules on sub-penny trading and on market data.
- 14.
See 11.
- 15.
Earlier in 2013, the Securities and Exchange Commission launched its internal Market Information Data Analytics System (MIDAS), which provides the agency with data about every displayed order posted on national exchanges. According to the SEC, MIDAS collects one billion records time-stamped to the microsecond. “The information comes from the consolidated tapes and proprietary feeds of each exchange and includes posted orders and quotes, modifications and cancellations, and trade executions both on- and off-exchange,” the SEC notes.
- 16.
The Glass-Steagall Act, also formally known as the Banking Act of 1933, was passed in 1933 by Congress in 1933, as an emergency response to the collapse of some 5000 banks during the Great Depression. The law, repealed in 1999, was designed to prohibit commercial banks from engaging in the investment business and establishing a division between both sides of the banking business.
- 17.
Aside from flash crashes, there were well-reported glitches. For example, the price of the stock in Kraft Foods (NASDAQ: KRFT) surged 25% within 1 min soon after the market opened. This glitch was blamed on a broker error by NASDAQ that affected multiple exchanges. “Investors were hit with another stock-trading glitch Wednesday, this one in a household name – Kraft Foods – which saw dozens of trades canceled when a broker error caused shares to soar shortly after the opening bell,” according to The Wall Street Journal. See Kraft Hit by Trading Glitch, Wall Street Journal, October 3, 2012, Alexandra Scaggs and Matt Jarzemsky.
- 18.
The electronic system of the New York Stock Exchange once used to route market and limit orders from customers, or their agents, to a specialist on the floor of the exchange. SuperDOT succeeded the Designated Order Turnaround (DOT) system. By 2009, SuperDOT was replaced by the NYSE’s Super Display Book system.
- 19.
For additional information, see Robert A. Schwartz and Liuren Wu, “Equity Trading in the Fast Lane: The Staccato Alternative,” The Journal of Portfolio Management Invited Editorial, Spring 2013, 39 (3) 3–6; DOI: https://doi.org/10.3905/jpm.2013.39.003. (Reprinted in this book on page 97).
- 20.
See 8. Two years later, Reuters reported that the USA supported 11 stock exchanges.
- 21.
Refers to federal legislation introduced on June 4, 1975, to amend the Securities Exchange Act of 1934. The 1975 amendments instructed the Securities and Exchange Commission to cooperate with the industry in creating a National Market System, along with an ambitious system for the clearance and settlement of securities transactions nationwide. The amendments also provided for the prohibition of fixed-commission rates, promulgated earlier by the SEC in its Rule 19b-3.
- 22.
See 13.
- 23.
Mary Jo White was sworn in the 31st Chair of the Securities and Exchange Commission on April 10, 2013, and as of writing was stepping down in January 2017.
- 24.
High stock prices are still an issue in the aftermath of the conference. See CEO sounds of on Wall Street’s high share prices, John Aidan Byrne. New York Post, June 11, 2016 http://nypost.com/2016/06/11/bats-ceo-sounds-off-on-wall-streets-high-share-price
- 25.
Ibid.
- 26.
Trading data continued to be an increasingly controversial topic in the industry in the wake of this conference, with critics complaining about rising costs. As an example of the costs charged data users, Intercontinental Exchange, which owns NYSE, data, and connectivity sales were $477 m, or 41%, of revenues in the first quarter of 2016. That was up 6% for the year, and data sales alone rose 9% annually.
See There’s a new ‘hot-button’ issue on Wall Street, and battle lines are being drawn. BusinessInsider, Matt Turner, November 3, 2016 http://www.businessinsider.com/stock-exchanges-market-data-cost-becoming-big-issue-2016-10 Matt Turner, November 3, 2016.
Fight Over Market Data Fees Is Going to Get Ugly, TabbForum, Larry Tabb. December 28, 2016 http://tabbforum.com/opinions/fight-over-market-data-fees-is-going-to-get-ugly
- 27.
Ibid.
- 28.
See 4.
- 29.
The New York Exchange Stock demutualized in 2006 and became a for-profit, publicly traded company.
- 30.
Founder, Chairman and CEO of Intercontinental Exchange (ICE) and Chairman of the New York Stock Exchange. ICE acquired the NYSE in 2013. See Buying the N.Y.S.E., in One Shot. New York Times. Nathaniel Popperjan, January 19, 2013 http://www.nytimes.com/2013/01/20/business/jeffrey-sprechers-improbable-path-to-buying-the-nyse.html
- 31.
See Brooks’ earlier comments on his proposal for a quote-to-trade ratio. Related terms (and of a controversial nature) include spoofing and quote stuffing. The latter is the practice of submitting an excessive amount of larger orders to buy or sell stocks in fractions of a second and then cancelling the orders almost immediately.
- 32.
The Buttonwood Agreement, signed by 24 stock brokers under a buttonwood tree outside of 68 Wall Street, in lower Manhattan, on May 17, 1792, created the New York Stock & Exchange Board, now known as the New York Stock Exchange.
- 33.
The Wharton School of the University of Pennsylvania is the business school of the University of Pennsylvania, a private university in Philadelphia, Pennsylvania.
- 34.
Sergey Aleynikov, the former Goldman Sachs programmer, was accused of stealing the bank’s high-frequency trading code.
- 35.
See 13.
- 36.
See Regulation T Filings, http://www.finra.org/industry/regulation-t-filings. Source: FINRA.
- 37.
See 8.
- 38.
See FINRA Makes Dark Pool Data Available Free to the Investing Public.
FINRA News Release, June 2, 2014 http://www.finra.org/newsroom/2014/finra-makes-dark-pool-data-available-free-investing-public.
See also FINRA Publishes ATS Block-Size Trade Data, FINRA News Release, October, 3, 2016 http://www.finra.org/newsroom/2016/finra-publishes-ats-block-size-trade-data.
- 39.
Founder of Bernard L. Madoff Investment Securities, better known publicly for perpetrating what is regarded as the largest Ponzi scheme in financial history. Madoff, a former NASDAQ Chairman, was also a market structure activist in Washington, long before this Ponzi scandal was exposed.
- 40.
Accenture: Went to a Penny at 2:48 p.m. Matt Phillips, Wall Street Journal, Marketbeat, May 6, 2016 http://blogs.wsj.com/marketbeat/2010/05/06/accenture-went-to-a-penny-at-248-pm/
- 41.
See 1.
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Brooks, A.M. (2019). A Trader’s Perspective. In: Schwartz, R., Byrne, J., Stempel, E. (eds) Market Integrity. Zicklin School of Business Financial Markets Series. Springer, Cham. https://doi.org/10.1007/978-3-030-02871-8_5
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