Jeff Sprecher’s Market Structure Comments
We have long championed a market-based approach to fixing our market structure issues. But the problem with this is approach is that industry enablers, such as the stock exchanges, have had no motivation to change the model which has been feeding their bottom line. However, the environment for market structure reform has suddenly changed after the release of “Flash Boys” and the industry now seems to realize that if they don’t attempt to address these market structure issues themselves then the regulators will do it for them.
What is needed now is some strong leadership from inside the industry to get these changes accomplished. For years, stock exchange bosses have resisted this leadership position and instead chose to just protect their own models while even resorted to attacking those who questioned some of their practices. But last week a leader emerged from the stock exchange community that we think has a good chance of accomplishing some of the market based reforms that we have recommended for years now. That leader is Jeff Sprecher, CEO of the Intercontinental Exchange. In a conference call after their earnings report, Jeff Sprecher laid out his vision for the market structure reform. Here are some excerpts from his conference call comments :
“Many parties share responsibility for today’s market model, including incumbent exchanges like The New York Stock Exchange. Most importantly, we, in the industry, must provide the leadership to respond to needed change. And we’re encouraged by the SEC’s work and recent comments acknowledging the need to address market complexity. Years ago, the market’s reaction to a perceived lack of transparency and fairness was to create competition at the exchange level. Ultimately, this went further than most could have anticipated. And this has led to extreme fragmentation, with over 50 venues to trade the same lifted securities. While a national market system linking these venues together is a worthy goal, it has resulted in an overly complex structure with many unintended consequences. Historically, markets naturally formed up in a single venue to establish liquidity and the best price discovery. Today’s fragmentation of such standardized markets is unnatural for the ultimate end-user and it tends to be promoted by those who seek to benefit from assets to better information. With extreme fragmentation, buyers and sellers have no choice but to seek to form a single price discovery stream by employing smart order routers, algorithms and high-frequency strategies. And to maintain liquidity, you’ve seen the convergence of market makers and high-frequency trading firms with very little means to distinguish meritorious activity from that, which can be disruptive. It’s certainly a positive fact that technology and automation has tightened bid offer spreads, but the fragmentation and instability of the market today has also increased its risk and complexity.”
On Maker/Taker and Payment For Order Flow:
“We’ve advocated for the regulatory elimination of maker-taker fees coupled with the reduction and equalization of access fees in the U.S. equity markets. This would expose the low exchange capture fees that I just mentioned, directly to all market participants. Maker-taker fees also create incentives for intermediaries to potentially place their own interest ahead of the obligation to customers. And I believe the vast majority of brokers are honest actors who want to place their customer’s interests first, but they’re being put in an increasingly untenable position with regard to best execution requirements. The imbalance in maker-taker fees creates fee arbitrageurs that add to market volume, while simply trying to buy on one exchange and sell on another in risk-free trades, while not actually wanting to own stocks. Encouraging transient liquidity signals is potentially as risky as encouraging transient price signals. Because traders not only rely on price information, they also rely on volume information when making trading decisions. The SEC has already placed limits on exchange fees. And thus, we believe that these limits could be updated to eliminate maker-taker pricing, while equalizing exchange access fees at lower levels for all investors.”
“I do not believe that it’s healthy for exchanges and trading venues to pay for order flow. People talk about that as if it is liquidity, but because they are both maker-taker venues and then taker-maker venues, you end up with people buying on one venue and selling on another venue and not having any interest in really owning shares. And in other markets where we’ve got competitors that are doing massive payment for order flow and rebate structures, we end up with customers that want to advantage themselves of those. And what they do is they end up doing big low-risk trades, trades that are way out the curve, butterfly trades that carry no risk or low risk. They do them in the middle of the night. They do these big volume trades, and then the exchanges all go run around and talk about how fabulous their volumes are and use that as a marketing move technique to try to attract the true hedgers into a market that really, by that design, is incredibly illiquid and is a roach motel. And so I am not a fan of market structures that create false volume. But again, false volume signals, I think, are as wrong as false price signals, which — in which case, most people would go to jail.”
On Order Types:
“The New York Stock Exchange had a significant opportunity to offer solutions that rebuild confidence and protect shareholder value. And we believe that we can start by unilaterally reducing the excessive complexity that exists today, such as the proliferation of order types. Therefore, the first step towards making our markets less complex, we will voluntarily reduce the number of order types at our U.S. equity exchanges. We’ve identified over 1 dozen existing order types that we plan to apply to the SEC for rule changes to eliminate. And beyond that, we will continue to evaluate our other order types to identify those that may not be providing the market with true utility. Too many of these order types were developed in an attempt to replicate dark pool trading or to segment the market to try to attract one type of investor over another type of investor.”
“The SEC has recently completed a comprehensive audit of order types, and we believe that exchanges and dark pools should adopt a moratorium on creating any new types of orders. We had a spirited internal debate on whether we should unilaterally begin eliminating order types, and certainly, there were some who did not initially like this idea. You see, we have 1/2 a dozen-or-so more new order types that are in the works, and some of them have already been built into our matching engines and are ready to launch. These new order types are smart, they’re innovative, and some may really put the hurt on our competition. However, I suspect that they will further fragment the U.S. equities market, which will ultimately hurt investors. My colleagues worry that our competition won’t share our end user concerns and they’ll continue to develop products that’ll further fragment the market. If this is so, I reminded them that maybe we should be paying our competitors salaries because I believe they’re setting themselves up for long-term failures.
On Data Feeds:
“Our U.S. equity exchanges produce and sell raw data feeds, which include every single quote and cancellation that is submitted to the matching engine. Now some had called for us to further slow down the raw data feeds to match the output of the SIPs, but this would likely have exactly the opposite impact that its proponents are trying to achieve. Recall that traders currently receive their trade confirmations from matching engines at their native speeds, and active traders who are constantly buying and selling small numbers of shares, see stocks move through various price levels by employing this trading strategy. If the raw data were delayed to match the output of the SIP, this would give active traders significantly earlier knowledge of stock movements, well before the public, as a result of their active trade confirmations. This time advantage would be big enough to drive a truck through. That’s why simply slowing down the raw data feed would only create more problems. However, we do believe that there are a number of solutions that could be enacted to better ensure parity, so long as they were adopted by the entire industry. We could slow the raw data feeds or combine the raw data and the SIPs into single feeds or use technology to further speed up the SIPs. But all that would have to be done while simultaneously slowing trade confirmations, including those from dark pool matching engines to eliminate all trade data information advantages. But again, such speed equivalence changes would need to be universally adopted for them to have any impact, given today’s fragmented market structure.”
“I think to a certain degree, the exchanges are somewhat responsible for the fragmentation of the market by what was perceived as innovation with all these new order types and rates. And to me, it’s not completely surprising that people wanted to flee those markets and trade elsewhere. Beyond that, what’s saddening about the U.S. equity market is that when I go out and talk to my friends, they do not have confidence in those markets and that is a — trying to take a bigger piece of a shrinking pie is a silly business, and we should all be trying in this industry to grow that pie. And yes, we can bang each other’s heads and compete for pieces of pie, but the reality is, if you look at the quality of people that are writing algorithms, these people are literally some of the smartest people in the world and we, as an industry, have been deployed on trying to get pieces of a shrinking pie and it’s just from a societal standpoint, it seems like a misallocation of resources.