In case you missed it, we recently published proposals to enhance market structure in our new TotalMarkets blueprint.
The effort follows our Revitalize campaign from 2017 and shares some of the same goals and proposals.
Revitalize focused on ways to encourage more capital formation: helping listed companies stay public and encouraging more IPOs into the U.S. equity market. It targeted three key areas: regulatory reform, long-termism and market structure.
TotalMarkets takes the market structure recommendations from Revitalize and expands on them. It has five core recommendations, the first two carry over from Revitalize:
- UTP: Allow suspension of unlisted trading privileges (UTP) for thinly-traded securities, so that issuers can opt in to a simplified liquidity model for on-exchange trading.
- Intelligent ticks and rebates: Combat a one-size-fits-all market structure and improve market quality.
- OPR: Reform the Order Protection Rule (OPR); specifically, we are proposing a market share threshold of 1.5% to address the concern that the Regulation National Market System (Reg NMS) “forces brokers to connect to all venues regardless of the cost benefit” and contributes to fragmentation.
- Retail: Modernize the definition of professional and non-professional market data users and clarify Vendor Display Rule (VDR) to provide more efficiencies and cost savings in market data.
- SIP: Consolidate Securities Information Processors (SIPs) to provide administrative and technology efficiencies. Remove extraneous data content on the SIPs to offer cost savings. Increasing industry participation through voting representation. Address geographic latency through a distributed SIP.
The topics in Total Markets have been extensively discussed and debated within the industry for years. However, rather than constantly add fixes, now is the time to begin a holistic conversation on the state of the market structure.
Recent changes to market structure—from the tick pilot to the new 606 reporting to multiple rounds of additional dark pool disclosures—have simply added costs and complexity, not reduced costs or simplified markets.
The reality is U.S. equity markets remain the best in the world. We attract the most capital, have the tightest spreads and the most liquidity. That’s thanks to rules introduced by Reg NMS that made our markets transparent, competitive and equally accessible to all.
That said, the markets have modernized since Reg NMS was introduced. At its inception, many orders were still being handled manually, and computers that were sending orders couldn’t “hit” all the quotes they could see. It was no surprise that some prescriptive rules were required. . Now, however, almost all trading is automated. Venues are interconnected, and prices and liquidity are shared at practically the speed of light. The routing of orders is data-driven, systematic and hyper-focused on cost.
Underlying the majority of our proposals is an acknowledgment that, as markets have modernized and automated, a “one-size-fits-all” ruleset, while technically “equal” to all, isn’t necessarily considered fair by many participants. Although what each participant believes to be unfair tends to reflect their own experience and best interests.
For example, our proposal to limit the Order Protection Rule to larger markets makes sense to most participants. In addition to eliminating “forced” connection costs, it should also help reduce fragmentation but still ensure all brokers are required to deliver best-prices on the majority of orders, thereby protecting Main Street investors. Smaller markets that are not subject to OPR would then be free to innovate in a way that exchanges are not able to today, potentially reducing the importance of speed in trading.
Similarly, distributing the SIP eliminates the geographic latency that many institutional investors say is a fundamental weakness with the current model, without reducing the speed and simplicity of the SIP as the source of the best prices for the public to use and benchmark against.
Data also shows that large-cap and small-cap stocks, or high- and low-priced stocks, trade very differently now that they are all trading electronically. Those who have followed our thinking know that smaller-cap stocks trade less and have wider spreads (also see Chart 1).
Chart 1: Average Spread (BPS) vs. ADV by Market Cap
Allowing thinly traded companies to opt-in to trading only on their primary exchange will let them simplify trading, making it easier for investors and market makers to find each other.
Intelligent tick sizes will also help undo the “one-tick-fits-all” approach which leads to many large-cap stocks trading multiple ticks wide and with significant odd lots inside the public NBBO on the SIP.
Chart 2: Spread vs. Odd Lot Percentage
Overall, TotalMarkets isn’t rewriting the rules that have been created over decades to produce the market that we have today. It does, however, offer a more holistic approach to market structure reform that advocates for more choice and flexibility, where the benefits outweigh the costs.
But with choice comes responsibility. Fortunately, the modernization of markets has brought significant improvements in the data and analytics that can now be made available. We’ve said this before: the industry should use that data to quantify costs and benefits of different choices. That applies here too. Enhanced metrics will need to be computed to show accountability, and ensure investors really are getting the best “all in cost” execution.
Ultimately, TotalMarkets aims to let everyone work out what’s “fair” for them.