Panel, Conference Presentation
The Shifting Sands of Market Structure: Equity Trading in the Spotlight
Milken InstituteKevin Cowan, Stephen McCauley, Seth Marin, Sianna Mastofi, Jamil Nazarelli, Jatin Suravanshi
- SEC market structure discussions are characterized as data-driven and evidence-based, with 13 directives covering five topics: preventing instability, addressing fairness and HFT, enhancing transparency, mitigating conflicts of interest, and supporting small companies; however, these directives are viewed by some as cosmetic changes or a measured "standoff" approach, with implementation of Dodd-Frank provisions cited as five years overdue.
- US equity markets are described as highly efficient with best price guarantees and significant improvements in execution quality over the last 10 to 15 years due to Rule 605 and 606, while Canada faces challenges with off-exchange trading limits, TradeAt rules, and lower liquidity volume, prompting the launch of new venues in September to align with US economics.
- The Tick Size Pilot is a near-term, two-phased initiative (including a venture exchange model) driven by congressional pressure and political factors, with stakeholders debating whether wider tick sizes will result in bundled research and more IPOs or merely cause a wealth transfer from investors to dealers, with some practitioners dismissing the belief that wider ticks will fix small-cap coverage.
- Off-exchange trading is a significant concern, accounting for 43.3% of US volume in the fourth quarter (broken down into retail wholesalers, dark ATSs, hidden exchange orders, and single dealer platforms), whereas Canadian dark trading remains at 5% to 8%, leading to debates on whether 40% off-exchange volume creates systemic risks or merely reflects efficient liquidity sourcing.
- Execution costs and structures are shifting, with institutional access fees dropping from $0.04–$0.06 fifteen years ago to $0.01–$0.02 today, making the 0.3 cent access fee a significant cost driver, while regulatory proposals to link research payments to commissions in Europe and Canada's TradeAt rules raise concerns about wealth transfers between retail and institutional investors.
- Market participants anticipate that a one-size-fits-all regulatory approach is ineffective, noting that execution quality varies between retail and institutional firms, and that dark pools, while created for anonymity and size, may suffer from toxic flow and inferior execution quality compared to lit exchanges, with some firms quantifying these differences through information content and rebate structure analysis.
- International regulatory trends include Europe struggling with fragmented rules and potentially implementing minimum trade sizes for dark pools (e.g., 5,000 shares) and price constraints, while Canada is viewed as a potential model for addressing HFT and dark pools with simpler rules, and the US SEC is developing a market structure website to increase transparency.
- Risks identified include the potential for wider tick sizes to increase trading costs by 40 to 50 basis points, the opportunity cost of missing trades, and the possibility that restricting off-exchange trading (as in Canada) would worsen execution for retail investors while benefiting institutions, creating a public policy dilemma regarding wealth redistribution.
- Institutional investors face data gaps regarding order handling and lack analogous disclosures to those available for retail investors, leading some to default to exchanges which may result in inferior outcomes, while the proliferation of ATSs has led to average execution sizes in dark pools being smaller than those on lit exchanges despite the original intent to trade large blocks without market impact.
- Future expectations involve the SEC completing fill-in-the-blank provisions from Dodd-Frank, with a specific focus on the TIC pilot and venture exchange model, while stakeholders emphasize the need for a proportionate regulatory regime and diverse tools to build vibrant markets for small and mid-cap companies rather than relying solely on tick size adjustments.