Four Regulatory Questions on US Equity Market Structure

TABB Forum
June 26, 2017

This article was published on the TABB Forum on June 23, 2017.

With the House Financial Services Capital Markets Subcommittee scheduled to hold a hearing Tuesday on U.S. equity market structure, industry participants will be watching closely to see how four issues in particular will be addressed.

Tuesday morning, the House Financial Services Capital Markets Subcommittee will hold a hearing on U.S. equity market structure entitled, “U.S. Equity Market Structure Part I: A Review of the Evolution of Today’s Equity Market Structure and How We Got Here.”

Tuesday’s hearing is not the first time the Subcommittee has explored equity market structure. In 2014, the Subcommittee looked at Securities and Exchange Commission Regulation National Market System (Reg. NMS). And, based on the “Part I” reference in the hearing title, we expect there to be subsequent events focused on this topic. The Financial Services Committee is not alone in reviewing these issues; the Senate Banking Committee has done its own diligence in the past few years.

As we prepare for Tuesday’s statements, testimony, and discussion, we will be watching to see how these four issues are addressed:

1. What happens to the Consolidated Audit Trail and its proposed fee structure?

The consolidated audit trail (CAT), first considered by the SEC in 2010, was originally intended to “enable regulators to track information related to trading orders received and executed across the securities markets.”  

Over the past seven years, the CAT National Market System (NMS) plan set forth by self-regulatory organizations has been subject to significant criticism, questioning the cost-benefit analysis for such a substantial undertaking. Many market participants have suggested to the SEC that the original goals of the CAT can now be more easily achieved through improved data, technology, and analytics by the exchanges and the Commission.

Recently, the exchanges proposed rule changes to the fee structure for “Industry Members” that would, if adopted, result in many of the costs for the CAT being passed down from the exchanges to the participants, increasing the cost of transactions in equity markets. The Securities Industry and Financial Market Association, among others, recently expressed concerns for how the CAT NMS fee structure was conceived, its impact, and the potential ramifications for equity market structure conditions.

2. Do speed bumps matter?

In the past few years, much has been made of new market structure features designed to “slow” down trading. The most notable example was the Commission’s approval of Investors’ Exchange LLC’s (IEX’s) application to register as a national securities exchange that was published concurrently with the Commission interpretation and staff guidance related to automated securities prices that are subject to a small delay or “speed” bump when being accessed.

In the months afterwards, trading venues responded. Recently, the Commission approved a New York Stock Exchange rule filing that allows a 350-microsecond delay for small and mid-cap companies traded on its NYSE American exchange. The Chicago Stock Exchange has proposed a similar “speed bump” functionality. Nasdaq has a pending request (which has already been the subject of public comment and subsequent Nasdaq amendment) before the SEC for an “extended life priority” (ELO) order that would be a new order type that would “rest on the book for a minimum fixed resting time and receive priority over other orders entered at the same price” and “could not be amended or cancelled and would be eligible for execution during the committed resting time.”

3. Whether and how to address market volatility.

Ever since the May 6, 2010 “flash crash,” regulators and legislators have shown an increased interest in episodes where financial products experience an extraordinarily rapid price decline and recovery in a compressed period of time. These unique volatility episodes have been identified by policymakers as occurrences that need to be evaluated and addressed to ensure market resiliency and reliability.

To be sure, significant work has been done by exchanges, market participants, regulators, and self-regulatory organizations. Even the Commission has formed an Equity Market Structure Advisory Committee. However, particularly on Capitol Hill, this is an area that Members of Congress continue to hear about from constituents and, as a result, remains a prominent component of any discussion related to market structure. We will be interested to see how much of the discussion Tuesday revolves around these issues.

4. Can a Three-Commissioner SEC Effectuate Policy?

Chairman Jay Clayton was sworn in less than two months ago. Since then, he has appointed a team of senior advisors and division directors, with some positions (including a Director of the Division of Trading & Markets) still vacant.

Chairman Clayton joins Commissioners Mike Piwowar and Kara Stein, giving Republicans a 2-1 majority. This should allow the SEC to move forward with an agenda consistent with the Trump Administration’s goals to foster liquid markets that facilitate lending, job creation, and economic growth.

However, the SEC’s regulations require at least three members to satisfy its quorum rules. This means that, while the Commission only has three members, all of them must participate for the Commission to take action, effectively giving Commissioner Stein “veto power” over any action simply by not attending or participating.

Tuesday’s hearing is Chairman Clayton’s first public appearance on Capitol Hill. It will be interesting to hear how he expects to lead the Commission in the months before the two vacant seats are filled.