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Time To Recalibrate

22

June, 2012

While we were busy at the CFTC on Wednesday, there was some other action going on over at a a Congressional Hearing titled “Market Structure: Ensuring Orderly, Efficient, Innovative and Competitive Markets for Issuers and Investors.”  There were two panels comprised of 11 industry witnesses.  We thought the testimony of Duncan Niederauer, CEO of the NYSE, was extremely telling.  The NYSE seems to have taken this opportunity to  “recalibrate”.  Below are some key points of the NYSE CEO’s testimony :

On dark pools: “Is it fair, for example, that a small number of participants in private markets receive the highest quality orders, with no benefit to the public markets? Does it make sense that one-third of the market does not provide public quotations of the prices at which securities may be bought and sold, or that certain venues have to provide fair access to their markets, but others do not? Why has the volume of securities trading in dark pools tripled over the past few years, despite the intent of Regulation NMS to incent the public display of securities orders?”

On confidence (or lack of) in the markets: “Despite the positive effects of competition for investors, many investors nevertheless lack confidence in our securities markets. A number of factors have contributed to this lack of investor confidence, including some aspects of the structure of our equity markets.”

On the difference between exchanges and dark pools: “Regulated exchanges, such as the NYSE, serve as price-makers. Price makers are critical to the price discovery process .  Alternative trading venues, by contrast, are price matchers: they match willing buyers and sellers that participate in their venues, but do not contribute to price discovery by displaying quotes to be included in the NBBO. But we need to ask ourselves at what level does price discovery materially suffer from gains in the market share by price matchers?”

On order routing options: “Since the implementation of Regulation NMS, broker-dealers now have at least 4 options: internalizing the order, routing it to one of over 200 other broker-dealers, routing it to any one of more than 40 dark pools, or routing it to an exchange where the order will likely contribute to establishing the best price. These options have increased because technology has enabled and the SEC has permitted non-exchange trading centers to create a very sophisticated web of connectivity which allows them to give select groups of traders and clients access to those orders before anyone else each with its own level of conflicted interest. It is only after select customers have determined they do not want to execute the order that the order finds its way into the public markets, and only then does the order have the opportunity to contribute to the price discovery process.”

On spreads: “A common argument made in support of the growth in off-exchange trading is that spreads have decreased dramatically as a result of the increased level of competition to exchanges through the adoption of Regulation NMS. However, since 2006, in percentage terms, spreads are actually wider by 2.9 basis points. Again, what this tells us is that there is a dilution of market quality to the detriment of investors.”

Even more interesting than the prepared testimony was the comments that Duncan Niederauer made during the hearing.  According to Bloomberg , he said “The public has never been more disconnected.  At the end of the day, the citizenry has lost trust and confidence in the underlying mechanism.  What used to be an investors market is now thought of as a traders market.  We convinced ourselves along the way that speed is synonymous with quality and in some cases it might be. In other cases, it clearly isn’t.”

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