The Market Structure Debate: Our Predictions for 2016

Most of the market structure debate in 2015 was dominated by three subjects: The strange New York Stock Exchange shutdown on July 8th; the wrenching volatility on August 24^th and resultant ETF Flash Crashes; and IEX’s September 15th application for exchange status, which suddenly became controversial.

So what do we expect to see in 2016?

1- SEC Okays IEX’s Application. We believe this will happen probably in the second quarter of 2016. The application, subject to a lengthy and spirited comment period, has turned into a referendum on modern market structure, pitting entrenched status-quo participants against those seeking innovation and market simplification. We believe the SEC will take a pro-innovation stance.

2 – Dark Pool Lawsuits Settled. The SEC and New York Attorney General’s lawsuits over anti-client dark pool practices at Barclays and Credit Suisse will be settled. In both cases, the banks are accused of giving favorable treatment to high-frequency traders at the expense of investors. We believe the settlements will create another market structure dust-up when they are announced.  Investors will be shocked at how these firms treated their orders. The word “rigged” may once again rear its ugly head.

3 – SEC Dark Pool Regulation Approved. The amendment to Reg ATS, which will increase dark pool transparency, will bring forth heavy comments from exchanges, brokers and dark pools. That will delay its ultimate approval until the end of the year. We also expect this is just the first step by the SEC in addressing off-exchange volume. Another proposal dealing with non-ATS off exchange trading, such as market internalizers, will come in 2017.

4 – ETF Flash Crash “Solutions”. The ETF Flash Crash of August 24^th will lead to two new rule proposals. The first will likely tweak Limit Up/Down (LULD) bands to prevent an excessive number of trading halts in the midst of serious volatility. Those bands exist to prevent trades from occurring outside a specified range in times of market stress. The second proposal will require indices to change their pricing calculations from the primary market to the consolidated tape. Previous calculations did not take into account prices across all exchanges, but only at the exchange where the index component is listed.

5 – Tick Size Pilot Delayed – Again. Implementation of the SEC Tick Size Pilot program, proposed to boost much-needed liquidity in small to mid-cap companies, scheduled to begin October 3, 2016, will be delayed again. Exchanges and brokers will request the extension to 2017 due to technical issues.

6 – Maker-Taker Pilot Will Be Proposed By The SEC.  Similar to the Tick Size pilot, the proposal will contain various test buckets with slight variations ranging from a reduction in access fee to a flat rate for both adding/taking liquidity. Maker-taker fee structures can influence where and how stocks get traded as some participants seek the biggest rebates from trading venues, the pilot program could create a more pure supply-demand trading and pricing environment for stocks.

7 – Strike Two for BATS IPO. BATS’ second attempt to go public will be derailed, this time due to a high profile market structure event, not necessarily related to BATS itself.

8 – Trading Tax Campaign Issue. As the candidates for president ratchet up their rhetoric in pursuit of the White House, a financial transaction tax, brought up earlier by Hillary Clinton, will again be proposed by other political candidates. But it will not gain any traction as a campaign issue because of the complexity of the subject. In addition, alternative campaign rhetoric focused on big banks works better.

9 – CAT Winner Chosen But Process Drags On. The SEC will finally select a winning bid to build the Consolidated Audit Trail, viewed as the SEC’s Holy Grail for tracking all market trading activity. Unfortunately, exchanges will continue to amend the plan, slowing the actual build-out.  We do not expect to see a working CAT for at least 3 more years.

10 – HFT Arms Race Continues to Escalate. Exchanges will continue to roll out faster services that their largest clients will need to buy in order to stay competitive with each other. Meanwhile HFTs will continue to explore new and outrageous ways, such as lasers, to gain microsecond advantages.