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From Securities Regulation Daily, June 20, 2014

SEC Chair says markets not “broken” or “static,” puts Regulation NMS in context

By Mark S. Nelson, J.D.

SEC Chair Mary Jo White today reiterated her belief that U.S. markets are neither “broken” nor “static” in a speech to the Economic Club of New York. Her remarks come at the end of a week that saw two different Senate panels examine the role of high frequency trading in U.S. markets and just shy of three weeks after she spoke about the SEC’s renewed focus on market transparency rules for dark venues and other market participants while voicing skepticism that regulators can identify an “optimal trading speed” for high-frequency traders.

Taking the longer view. White’s latest speech emphasized the interplay between competition and regulation. Said White: “This dynamic reality means that we should not be chasing regulatory solutions that ‘fix’ our market structure once and for all.Our markets are not broken and they are not static.”

White also said regulators should follow an ongoing path that leads to “improved” markets. According to White, this approach would seek to avoid the pitfalls of becoming too focused on any one problem at a given time.

“If we stand too close to the particular problems in a particular market structure at a particular time, we may fail to fully understand the broader forces that are at work and the regulatory choices that are available,” said White.

Complexity and Regulation NMS. White said there are no easy explanations for the perceived increase in fragmentation of trading and the rising speed at which trades can be executed across markets. Specifically, she cast doubt on claims by some that the SEC’s adoption in 2007 of Regulation NMS led to greater fragmentation and made high-frequency trading possible.

White explained that although the trade-through requirement in Regulation NMS is often blamed for many of the ills cited by critics of today’s markets, the same fragmentation and speed issues arise in countries that have no equivalent to Regulation NMS.

Continuing her theme of taking a longer view of market regulations, White implied that regulators may want to decouple specific regulations from their place in time in order to determine which rules will help investors the most. “As a regulator assessing our markets, however, we cannot rely simply on the temporal juxtaposition of Regulation NMS and high-frequency trading. The issues and forces at play are more complex.”

As an example, White suggested that non-equities markets, like the CME Group, Inc.’s E-Mini, face the same types of issues that worry some about equities markets. The E-Mini, noted White, trades in a single market without the marker-taker model. Still, White said that over half of all E-Mini trades are done by high-frequency traders.

White’s emphasis today on a longer view of market regulations echoed her remarks from a few weeks ago regarding speed in modern markets. In a June 5 speech, White said the SEC should not disallow newer trading algorithms, but instead should look to aspects of this type of trading where regulators may be able to help investors.

White called on the SEC staff to draft an anti-disruptive trading rule that would protect market liquidity when it is most vulnerable to price disruptions from modern trading methods. But White stopped short of asking for market speed limits.

“I am personally wary of prescriptive regulation that attempts to identify an optimal trading speed, but I am receptive to more flexible, competitive solutions that could be adopted by trading venues,” said White.

This week, two Senate panels looked at high-frequency trading in the context of Regulation NMS. On Tuesday, the Homeland Security & Governmental Affairs Committee’s Permanent Subcommittee on Investigations queried industry representatives about conflicts of interest that may harm investors. A day later, the Senate’s Committee on Banking, Housing & Urban Affairs examined the impact of high-frequency trading on the U.S. economy.

Intermediation benefits and woes. White also addressed concerns that have been raised over the role of intermediation in today’s markets. She noted that the clearer distinctions between exchanges, brokers and dealers inherent in the earliest U.S. securities regulations have been blurred for many years.

Specifically, White noted the potential conflicts of interest between often combined brokers and dealers. Dealers and exchanges, White said, also can “collectively” work to lessen competition in dealers’ pricing.

Still other issues can arise when exchanges and brokers have too few competitors, but charge too much for their services, or dealers may engage in more intermediation than is needed. In the case of dealers, White said it can be tricky to identify the true costs of intermediation. She noted that dealer intermediation abuses are most likely for products that are actively traded. But White acknowledged that dealers also play a key role in keeping markets functioning for thinly traded products.

Fixed income initiatives. White spoke of the need to “carefully calibrate” future changes to fixed income markets. She wondered why these markets have not benefitted more from the technological changes that have swept through equities markets.

Said White: “I am therefore concerned that in the fixed income markets, technology is being leveraged simply to make the old, decentralized method of trading more efficient for market intermediaries, and its potential to achieve more widespread benefits for investors, including the broad availability of pre-trade pricing information, lower search costs, and greater price competition – especially for retail investors – is not being realized.”

To address these worries, White said the SEC will be working with the Financial Industry Regulatory Authority and the Municipal Securities Rulemaking Board to promote best execution in corporate and municipal bond trades and to reveal the true costs of these transactions to investors.

White also said she has asked the SEC staff to pursue an initiative to make pre-trade pricing data more accessible to fixed income investors. The initiative would focus on retail investors and will track an earlier initiative mentioned in a July 2012 report on municipal markets.

Companies: CME Group, Inc.

MainStory: TopStory SECNewsSpeeches ExchangesMarketRegulation

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