Role of an Exchange: The Future of Exchange Regulation
Stock exchanges have sought to protect investors since their inception. They do so through a myriad of ways, including through their listings, membership, surveillance, and enforcement functions. But financial markets in the United States are dynamic and evolve constantly. Successful investor protection therefore requires a dedication to regulatory innovation and an investment in nimble technology. Exchanges must find new ways to effectively screen and monitor their listed companies and trading members.
At Nasdaq, we believe that the future of regulation will incorporate cutting-edge technology like Artificial Intelligence and machine learning, leverage revolutionary systems such as the Consolidated Audit Trail, and develop agile frameworks that are ready for new and alternative markets.
Artificial Intelligence
Artificial Intelligence, or AI, is a term generally used to describe technologies that are able to “learn” from patterns in data and use predictive modeling to improve processes and achieve a stated objective. In the case of exchange regulation, Nasdaq already employs AI in the listings process to help sort through thousands of pages of company filings to identify potential listing issues. This frees up time for our listings staff to prioritize higher risk and complicated filings that require manual review. The result of machines and analysts working “side by side” is a more efficient and effective framework to ensure our listed companies remain compliant with our listing standards.
Nasdaq continues to build on the successful use of machine learning. As the technology continues to evolve, additional integration into the regulatory program becomes possible.
Consolidated Audit Trail
The Consolidated Audit Trail, or CAT, will transform the way regulators police the markets. Historically, an exchange could only see the activity occurring on its systems. For example, if a broker-dealer placed an order on behalf of its customer, the exchange had no easy way to determine who that customer was, whether the order passed through multiple parties before executing on the exchange, and whether parts of the order were executed elsewhere. That made it difficult to quickly identify parties responsible for potentially manipulative activity.
CAT changes this by collecting and identifying every order, cancellation, modification and trade execution for all exchange-listed equities and options across all U.S. markets. Exchanges will be able to incorporate this data into their surveillance patterns to make them more efficient and effective. That in turn will enable an exchange’s enforcement program to conduct investigations more expeditiously.
CAT creates a “one stop shop” that regulators can use to monitor markets and protect investors. Perhaps in the future, CAT and AI will work together, predicting nefarious activity before it occurs, allowing exchanges to block bad actors preemptively.
Agile Frameworks and New Markets
Exchanges will also need to remain agile in order to adapt to new markets, regulations, and regulatory challenges. The markets continue to expand outside of the traditional equities model, not only in terms of how trading occurs but also what is being traded. As investors look for new ways to put capital into the economy, exchanges must be prepared to initiate new regulatory systems and procedures to protect investors. Agile frameworks support a proactive mindset that will drive the innovation necessary to keep up with this changing landscape.
One way that Nasdaq has adapted to evolving markets is by stepping in where there is a regulatory vacuum. Take cryptocurrency as an example. In the United States right now, no comprehensive regulatory regime exists to oversee platforms that trade cryptocurrencies.
But Nasdaq understands the important of cryptocurrencies and the underlying blockchain technology. Before licensing our technology to cryptocurrency companies, we conduct robust due diligence to ensure that they take regulation as seriously as we do. We created our own set of guardrails that we expect participants to stay within, even if relevant laws do not. Nasdaq is in an unique position to do this because of our deep understanding of markets, technology, and regulation. As technology evolves faster than the government can pass new laws, exchanges must step up to address these challenges head on.
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Nasdaq entered the securities market in 1971 as the world’s first electronic stock market. An appreciation of innovative technologies is what launched us and what continues to drive us today. Our drive to innovate is matched only by our unwavering commitment to regulation. As we start a new decade and approach the 100th anniversary of the 1929 market crash, we see continued opportunity to marry our drive to transform with our dedication to protect. Our imagination is the only limit to our success.
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