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From Securities Regulation Daily, April 25, 2018

Commissioner Peirce makes case for less government intervention in national market system

By John Filar Atwood

Financial markets regulators would do well to be more humble about their ability to manage how market participants communicate and trade with each other, and in assessing the benefits of government intervention in the national market system over the past four decades, according to SEC Commissioner Hester Peirce. In remarks at the SIFMA equity market structure conference, she noted that markets that have not been extensively planned by regulators can be very effective in allocating resources to their best uses.

Peirce cited the work on the consolidated audit trail (CAT) as a reminder of how humbling market intervention can be. The CAT, which was designed by a committee of experts appointed by regulators, has proven very difficult to execute, she noted, while the market regularly and efficiently implements systems of far greater complexity. She believes that the CAT assigns decision-making rights to entities that do not bear the full cost of the decisions, an action that would be considered a failure if it happened in the markets.

Peirce recommended eliminating rules that interfere with efficient market communication and interactions. In her view, the mere existence of a rule that addresses a particular market structure issue should not be accepted as evidence that the rule was an appropriate response to a market failure when it was adopted, or that it remains necessary given changes in the market.

Order protection rule.She singled out the order protection rule, which she believes has exerted an outsized influence on the current shape of the equity markets. The rule distorts the markets in a number of ways, she said, including by forcing broker-dealers to prioritize price above everything else in their execution decisions, regardless of the needs or preferences of customers. In her view, the rule also pushes trading facilities toward increasing homogenization, and restricts exchanges to distinguishing themselves from each other in ways that do not necessarily improve issuer and investor choice.

She recommended that regulators consider whether it is worthwhile to continue focusing on regulatory adjustments to constrain market behavior that is driven primarily by the incentives created by the order protection rule. In her view, they should consider alternatives that provide investors with sufficient information and flexibility to determine, in light of their own trading objectives, whether a broker is capable of executing their trades in a manner consistent with best execution.

Self-regulation. Peirce suggested that regulators need to be sensitive to how statutory and regulatory requirements may be distorting or inhibiting competition. She pointed to self-regulation and the SEC’s long-standing reliance on self-regulatory organizations as an area worth closer scrutiny. Although she believes SROs are in a good position to respond quickly to rapidly changing markets, she acknowledged that commentators have long noted that self-regulation can sometimes impede competition within an industry.

She said that it is worth considering whether concerns about the anticompetitive effects of self-regulation become even more problematic in a world where exchanges have demutualized and increasingly see themselves as competitors to at least some of their members. She asked whether when SROs are for-profit corporations and compete with some of their member broker-dealers, it makes sense for them to play a prominent role in developing and administering national market system plans.

The Securities Acts Amendments of 1975 and Regulation NMS impose a particular vision on how market participants should communicate and interact with each other, which restricts the ability of trading platforms to innovate in ways that could address the needs and preferences of investors and issuers, according to Peirce. She noted that exchanges now must compete for order flow rather than provide innovative solutions to issuers and investors.

Agility, not uniformity.In her view, regulators need to recognize that a national market system is not a goal to be achieved, but should be a continuously developing system that is agile enough to adjust quickly to new technology and changing investor and issuer needs. Regulators should check the temptation to think they regulate financial markets to perfection, she added, and hopefully avoid the inflexible uniformity that can harm the markets.

She cited the challenges that thinly-traded stocks face in a highly regulated and carefully calibrated national market system. In her view, it is past time to consider possible alternatives, including the recommendation in the Department of the Treasury’s Capital Markets Report that the SEC consider allowing issuers to suspend unlisted trading privileges in their shares.

She also pointed out that it is remarkable that the Commission has to spend any resources attempting to find a solution to this issue. Markets solve this kind of problem through private ordering all the time, she noted, adding her belief that trading facilities, issuers, and investors could solve the problem if regulators would allow them the freedom to do it.

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