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From Securities Regulation Daily, June 5, 2014

White calls for enhancing market structure by addressing high frequency trading and promoting transparency

By Amanda Maine, J.D.

SEC Chair Mary Jo White spoke about the equity market structure in the U.S. and the SEC’s efforts to enhance it. She made her remarks at the Global Exchange and Brokerage Conference in New York City, sponsored by Sandler O'Neill & Partners.

Algorithmic marketplace. In her remarks, White observed that equity markets are dominated by computer algorithms, which generate orders at “a volume and speed that have transformed the nature of trading.” This has been beneficial to investors, White said. Institutional investors have seen a reduction in costs, volatility has decreased, and narrower spreads have benefited retail investors because they reflect the cost of trading immediately at the best prices, White said.

White maintained that, contrary to the assertions of other market watchers, the current market structure is “not fundamentally broken, let alone rigged.” However, the current market structure is not without issues, she said. In particular, she noted that many current market structure rules and industry practices were developed with manual markets in mind, without taking account of technological advances.

Enhancing market structure. White outlined several initiatives which the SEC has undertaken to address the challenges and changes in the current market structure. She emphasized that one of her most pressing concerns is market instability. The SEC and the securities industry have already implemented “limit up-limit down” to moderate price volatility in individual securities, she said. Market-wide circuit breakers are also in place to address volatility across the equities, options, and futures markets. In addition, the SEC is focused on “single points of failure” (SIPs) that can disrupt trading when a problem occurs. The exchanges have implemented several enhancements such as technology audits to improve their resilience, she said.

While the SEC does not want to prohibit algorithmic trading, it will continue to assess the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them, White said. She noted in particular the use of “aggressive, destabilizing trading strategies” that have the potential to exacerbate price volatility. To address this risk, White said that she has directed the SEC staff to develop a recommendation for an anti-disruptive trading rule.

Fragmentation. White noted that order flow in exchange-listed equities is divided among 11 exchanges, over forty alternative trading systems (ATS), and at least 250 broker-dealers. This can be a good thing, White said, because it encourages competition which results in lower trading fees. She voiced her concern about the proliferation of venues, however; the interconnectedness of systems increases the risk that a disruption in one system will also disrupt another. In addition, while the variety in trading venues can be beneficial, she expressed concern about unregulated dark trading venues, on which trading volume has increased from 25 percent in 2009 to 35 percent today. These dark trading venues lack transparency, which is one of the primary tools used by investors to protect their interests, White advised. She said that she has requested the SEC staff to prepare a recommendation about expanding the information about ATS operations and to make it available to the public. This information will be an important tool for investors; however, White added, the SEC must continue to examine whether dark trading volume is approaching a level that risks seriously undermining the quality of price discovery provided by lit venues.

Broker conflicts. White also spoke about how the SEC can mitigate broker conflicts. Fees and payments that are not passed through from brokers to customers can create conflicts of interest and raise questions about whether such conflicts can be effectively managed, she said. White noted that the SEC has brought enforcement actions against brokers who caused clients to pay higher fees than disclosed and for not disclosing that trades were made through an affiliate ATS. White has asked the staff to prepare a recommendation for a rule that would amend Rule 606 of Regulation NMS to enhance order routing disclosure. Such a rule would require disclosure of customer-specific information that a broker is expected to provide to each institutional customer on request. She is also asking that the exchanges conduct a comprehensive review of their order types, how they operate, and how they can be changed to support fair, orderly, and efficient markets.

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