Abstract
We have a great divergence of fascinating views on this panel and, I must add, from a variety of organizations in the financial services sector. As you know, the SEC published a Concept Release which is a part of the agency’s review of the existing structure of securities markets. In tandem with this initiative, the SEC raised this question: Is market regulation keeping pace with changes in technology and trading practices? High-frequency trading (HFT) is one of the areas it specifically singled out. The SEC asked for comments on whether high-frequency trading is a problem. And the agency, having identified some problems, asked if a new set of regulatory initiatives is required.
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Notes
- 1.
See Concept Release on Equity Market Structure, January 14, 2010: https://www.sec.gov/rules/concept/conceptarchive/conceptarch2010.shtml
See also SEC Press Release, announcing Concept Release, January 13, 2010: https://www.sec.gov/news/press/2010/2010-8.htm
- 2.
Referring to the US Federal Reserve’s so-called quantitative easing program in the wake of the 2007–2008 financial crisis.
- 3.
See Quarterly Journal of Economics, Vol. 130 November 2015 Issue 4: The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response. Budish, Eric, Peter Cramton, Shim, John. http://faculty.chicagobooth.edu/eric.budish/research/HFT-FrequentBatchAuctions.pdf
- 4.
For clarity, the speaker was also referring to present practices, insofar as BATS would presumably examine the profile of these brokers as a business practice anyway.
- 5.
See Chap. 4, Integrity of a Marketplace, for discussion on HFT.
- 6.
Ibid.
- 7.
Ibid.
- 8.
Ibid.
- 9.
According to scientists, it takes light 13.3 milliseconds to travel from Chicago to New York and back again.
- 10.
In a discrete time model, the system is characterized by a market based on fixed time intervals at a finite rate of change at each interval, rather than the “continuous” time model with almost instant executions as described by the speaker.
- 11.
On a lit exchange, such as the New York Stock Exchange, traders can interact with visible prices. The continuous limit order book is a feature of stock and future exchanges across the globe.
- 12.
At the time of the conference, the dark markets in Canada were Bloomberg Tradebook, Liquidnet, and TriAct Match Now.
- 13.
At the time of the conference, the lit markets in Canada were Alpha Exchange, Chi-X Canada, CX2 Canada, Lynx ATS, Omega ATS, Toronto Stock Exchange, IMX Select, and TSX Venture Exchange.
- 14.
Order-to-trade ratio refers to the ratio of orders received by a marketplace compared to the number of trades executed on that marketplace. As the speaker explained in a follow-up, when reviewing trade data, her group was looking for clusters of data that behaved in a similar manner and to then perform research into those clusters.
- 15.
“So, today, I am pleased to announce a new initiative we are launching that is designed to promote a fuller empirical understanding of the equity markets. SEC staff has prepared and assembled resources and data on the SEC’s web site focusing exclusively on equity market structure. The new web site should be available as early as next week and will serve as a central location for us to publicly share evolving data, research, and analysis.” SEC Chairman, Mary Jo White, Oct. 2, 2013. See full speech: https://www.sec.gov/news/speech/2013-spch100213mjw
- 16.
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.
- 17.
See The HOT Study: Phases I and II of IIROC’s Study of High Frequency Trading Activity on Canadian Equity Marketplaces. IIROC, December 12, 2012. http://www.iiroc.ca/Documents/2012/2fb137e3-4371-43bd-b567-59b789a1e4d7_en.pdf#search=HOT%20study
- 18.
A typical example of a direct market access client in Canada is a buy-side firm or money manager that is a large, sophisticated institution but is not a broker dealer.
- 19.
Nothing determined conclusively as to why the order-to-trade ration had gone back up.
- 20.
Measuring HFT trading in two ways by volume traded and then by total value traded.
- 21.
Most of the HFT trading volume in Canada is from US-based entities, such as broker dealers or proprietary trading firms.
- 22.
See FINRA 2012 Year in Review here: http://www.finra.org/newsroom/2013/2012-finra-year-review
“In 2012, FINRA implemented comprehensive cross-market surveillance patterns for the markets it regulates (the NYSE and NASDAQ families of markets and the OTC market for listed equities). These patterns address more than 50 threat scenarios and canvas approximately 80% of the listed equities market. FINRA will continue to pursue potential cross-market abuses and refine its surveillance patterns based on new threat scenarios and regulatory intelligence. FINRA also introduced a suite of surveillance patterns to further enhance oversight of trading in non-exchange-listed OTC equities, which will allow FINRA to better review for potential manipulative trading activity, such as frontrunning and marking the close. In addition, as TRACE* has provided increased transparency to the debt markets, FINRA has enhanced its ability to review for potential abuses common in transparent markets, such as wash sales, marking the close and trading ahead. In 2012, FINRA Market Regulation’s Trading and Market Making Examination (TMMS) program continued to implement a more risk-based approach to planning and conducting examinations. Thematic and cause examinations focused on trading issues associated with alternative trading systems, information barriers, the SEC’s market access rule and amendments to FINRA’s order protection rule.”
Source: FINRA 2012 Year in Review here: http://www.finra.org/newsroom/2013/2012-finra-year-review
*Trace is the acronym for Trade Reporting and Compliance Engine. According to FINRA, Trace is the “FINRA-developed vehicle that facilitates the mandatory reporting of over-the-counter secondary market transactions in eligible fixed income securities.”
- 23.
FINRA’s regulatory clients include the NYSE, NASDAQ, BATS, CBOE, IEX, BOX, and MIAX. See FINRA Regulatory Services: http://www.finra.org/industry/regulatory-services.
- 24.
A reference to FINRA Alerts or warnings to investors.
- 25.
Spoofing is defined under the 2010 Dodd-Frank Act as, “the illegal practice of bidding or offering with intent to cancel before execution.” Some regulators use the terms “spoofing” and “layering” interchangeably.
- 26.
See Chap. 4: Integrity of a Marketplace Moderator: Bob Pisani, Correspondent, CNBC.
- 27.
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.
- 28.
In a follow-up, Wunsch further explained that he was asking why should it be the primary goal of an exchange to preserve alpha. The goal historically of exchanges was to make money for its members, he said, not to preserve alpha. By the same token, he contended, the goal of regulation since the founding of US exchanges has been to destroy profit-seeking by members.
- 29.
The Buttonwood Agreement, signed by 24 stock brokers outside of 68 Wall Street in Lower Manhattan under a buttonwood tree, on May 17, 1792, created the New York Stock and Exchange Board, now known as the New York Stock Exchange.
- 30.
“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.
- 31.
The pilot eventually was approved by the Securities and Exchange Commission. See SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies. Press Release. Securities and Exchange Commission. May 6, 2015. https://www.sec.gov/news/pressrelease/2015-82.html
See also SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies. Center for Financial Stability, May 7, 2015. http://centerforfinancialstability.org/wp/?p=5987
- 32.
Focusing on Fundamentals: The Path to Address Equity Market Structure, speech delivered by SEC Chair Mary Jo White, October 2, 2013, Security Traders Association 80th Annual Market Structure Conference, Washington, DC. https://www.sec.gov/news/speech/2013-spch100213mjw
- 33.
See The Order Protection Rule, http://www.osc.gov.on.ca/en/Marketplaces_order-protection_index.htm
- 34.
At the time of the conference, Craig Lewis was chief economist at the SEC and was originally scheduled to join the panel.
- 35.
The general concept of “dueling algos” or algorithms is described in this piece, Dueling algorithms: If software companies design their algorithms with the sole intention of outperforming each other, the customer can be the loser. Larry Hardesty, MIT News. March 18, 2011. http://news.mit.edu/2011/dueling-algorithms-0318
- 36.
Whenever you buy or sell a stock, bond, or mutual fund, there are two important dates of which you should always be aware: the transaction date and the settlement date. The abbreviations T+1, T+2, and T+3 refer to the settlement date of security transactions and denote that the settlement occurs on a transaction date plus 1 day, plus 2 days, and plus 3 days. Source: Investopedia.
- 37.
SEC Approves Plan to Create Consolidated Audit Trail. Securities and Exchange Commission, Press Release, Washington, D.C., Nov. 15, 2016. https://www.sec.gov/news/pressrelease/2016-240.html
- 38.
For example, BATS earliest attempt for its IPO was scrapped after a software glitch sent its shares plunging a fraction of a cent within seconds, when the IPO was originally attempted on March 23, 2012.
- 39.
Nasdaq says software bug caused trading outage, John McCrank, Reuters August 29, 2013. http://www.reuters.com/article/us-nasdaq-halt-glitch-idUSBRE97S11420130829
- 40.
Under Reg NMS, the best price in the displayed market must be honored. Consequently, there is a mechanism to respond to a situation where that best price is out there but not accessible. So, if a market is having a technical problem, the market might have a quote that a participant can’t access. Under Reg NMS, if a repeated attempt by a market participant to access that quote during a single, one second period of time is unsuccessful, the participant can declare “self-help.” The participant does this by sending a notice to the exchange it is declaring self-help to. In practice, typically what market participants have done was blast a notification to the street that it has declared “self-help.” That allows a participant to immediately start ignoring the quote from that market having a tech problem, until such time as that market publicly acknowledges it is fixed. It might be a barometer of improvement in tech controls in that self-help declarations were much more common when this provision was originally introduced.
- 41.
The Flash Crash of May 6, 2010, lasted about 36 min, erasing 998.5 points in the Dow Jones Industrial Average and then quickly recouped much of the losses as the various indexes rapidly rebounded in this high-speed, electronic trading phenomenon.
- 42.
See NASDAQ Frequently Asked Questions: https://www.nasdaqtrader.com/content/MarketRegulation/LULD_FAQ.pdf
- 43.
The Securities and Exchange Commission adopted the final version of Rule 15c3-5 on November 3, 2010. See Risk Management Controls for Brokers or Dealers with Market Access. Securities and Exchange Commission. https://www.sec.gov/rules/final/2010/34-63241.pdf
- 44.
Regulation Systems Compliance and Integrity (Regulation SCI) is a set of rules created by the US Securities and Exchange Commission to monitor the security and capabilities of US securities markets’ technological infrastructure. The Commission adopted Regulation SCI and Form SCI (“Form”) in November 2014.
- 45.
See footnote 39.
- 46.
In the week after the 2010 Flash Crash, then SEC Chairman, Mary Jo White, convened a meeting of US exchange officials, and self-regulatory organizations generally, to look at ways to mitigate potentials points of failure in the marketplace officials.
- 47.
See footnote 44.
- 48.
See footnote 33.
- 49.
Aug. 1 stock trading fiasco costs Knight $604 M, USA Today, October 17, 2012. According to the opening paragraph in this AP story: “The Knight Capital Group trading firm said it lost $764.3 million in the third quarter because of a software glitch that flooded the stock market with trades one day in August, causing dozens of stocks to fluctuate wildly.” http://www.usatoday.com/story/money/markets/2012/10/17/knight-capital-earnings/1638817/
- 50.
See footnote 41.
- 51.
In Canada, this is National Instrument 23–103 Electronic Trading and Direct Electronic Access; and these rules are also found in the Universal Market Integrity Rules of the Investment Industry Regulatory Organization of Canada (IIROC).
- 52.
See footnote 42.
- 53.
In 2016, a mechanism for volatility thresholds was implemented by the Investment Industry Regulatory Organization of Canada (IIROC).
- 54.
See footnote 44.
- 55.
TRACE is the acronym for Trade Reporting and Compliance Engine. According to FINRA, TRACE is the “FINRA-developed vehicle that facilitates the mandatory reporting of over-the-counter secondary market transactions in eligible fixed income securities.” http://www.finra.org/industry/trace
- 56.
The Securities and Exchange Commission adopted the final version of Rule 15c3-5 on November 3, 2010. See Risk Management Controls for Brokers or Dealers with Market Access. Securities and Exchange Commission. https://www.sec.gov/rules/final/2010/34-63241.pdf
- 57.
See footnote 40.
- 58.
See footnote 10.
- 59.
Ibid.
- 60.
See footnote 40.
- 61.
See footnote 41.
- 62.
Steve Wunsch is the founder of the now defunct Arizona Stock Exchange, an electronic stock exchange based on call auction principles. The headquarters was in New York. A former Kidder Peabody vice president. Wunsch is also known for his expert knowledge of market structure and for his free enterprise outlook.
- 63.
Larry Tabb, writing in the Tabb Forum in December 2016, notes the concept of the consolidated/aggregated market data feed in the US equity 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.”
- 64.
OPRA is the acronym for the Options Price Reporting Authority.
- 65.
Jumpstart Our Business Startups (JOBS) Act https://www.sec.gov/spotlight/jobs-act.shtml
- 66.
See footnote 31. Referring to a proposed pilot program for trading small-cap stocks in wider minimum increments.
- 67.
Congressman Scott Garrett (R-NJ, 5th) 2003–2017 chaired the US House Financial Services Subcommittee.
On April 14, 2017, President Donald Trump nominated him to be chairman and president of the Export–Import Bank of the United States.
- 68.
See Chap. 5: A Trader’s Perspective: Andrew M. Brooks, Vice President and Head of US Equity Trading, T. Rowe Price Associates, Inc.
- 69.
Central limit order book, or CLOB, once proposed by regulators met with industry opposition in the late 1990s and early part of the twenty-first century.
- 70.
Securities and Exchange Commission Historical Society. http://www.sechistorical.org/
- 71.
Ralph Saul is listed in 1964 on the historical website, as Director, Division of Trading and Markets at the Securities and Exchange Commission.
- 72.
See footnotes 16 and 69.
- 73.
Example of this “utility” model would be the original AT&T entity created by the US government.
- 74.
The International Securities Exchange (ISE) www.ise.com/about-ise/
- 75.
See footnote 3.
- 76.
Referring to Professor Robert Schwartz’s widely known research, proposals, and support for a call market.
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Lehn, K., Budish, E., Dobrowsky, D., Gira, T., Swanson, E., Wunsch, S. (2019). Integrity of Market Regulation. 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_6
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