Beware Of Those Offering Holistic Reviews
Holistic review. We keep hearing this term being tossed around by many entrenched industry insiders. Regulators, exchange executives and large brokers are all calling for a holistic review of our equity market structure. Sounds great, right? But when all of these industry folks align on the same side of an issue, we start to question their motives. Are they asking for this to just slow down the reform process? Are they just holding out as long as possible so they can squeeze every last penny out of their high speed models?
The latest regulator calling for a holistic or comprehensive review is newly appointed SEC Commissioner Michael Piwowar. In a speech yesterday in London ,Commissioner Piwowar said:
“I therefore echo my colleagues at the Commission who recognize the need to review our current market structure and reiterate my support for a comprehensive review of U.S. equity market structure….The comprehensive equity market structure review I am advocating is an effort that will take a couple of years, not a couple of months, to do right.”
You read that right. It would take the SEC at least a couple of more years to conduct their comprehensive review. This is very frustrating since it’s already been six years since Reg NMS was implemented and opened the door to all sorts of HFT shenanigans. And it’s been almost four years since the SEC issued their Equity Market Concept Release where they were supposed to be looking into some of the controversial aspects of the equity market like the maker/taker model.
In addition to this time consuming multi-year approach, we took issue with a number of other items in Commissioner Piwowar’s speech:
1) The 1962 Market Crash vs the 2010 Flash Crash
In his speech, Commissioner Piwowar tried to compare the 1962 market crash to that of the May 2010 flash crash. This analogy has been used before by proponents of high frequency trading so we were a bit surprised to see a SEC commissioner use the same analogy. Commissioner Piwowar stated: “On May 28, 1962, the U.S. markets suffered a so-called “break.” As it turns out, sudden and unexpected market disruptions, in other words “breaks” or “flash crashes,” are not recent phenomena. Flash crashes occurred well before the emergence of computerized algorithmic trading, high-frequency (or low-latency) trading, alternative trading systems, smart order routing systems, decimalization, and even the founding of the National Association of Securities Dealers Automated Quotation System (NASDAQ).”
We do not agree that the ’62 crash was similar to the 2010 Flash Crash. First of all, the ’62 crash lasted all day and the market did not bounce back within minutes like it did in the Flash Crash. Also, stocks did not trade at stub quote levels of $0.01/share. And finally, there were valid fundamental reasons for the sell off as Warren Buffet states in this 1962 video : “I think the President’s action on steel probably had something to do with the timing of the decline. There was some stock that was forced upon the market both by margin calls from brokers and from improperly secured bank loans. This in turn set up a self-generating mechanism on the downside.”
2) The UK Foresight Model
Commissioner Piwowar would like to model the SEC’s comprehensive review after the UK Foresight Project on Computer Trading in Financial Markets. He said: “The UK Foresight model is one that we should entertain in the U.S. The SEC can benefit tremendously from collaboration with market structure experts from both the private sector and the academic world. “ While we have devoted quite a few Themis blog posts to debunking many of the Foresight projects academic paper, the real problem with using outside research is that it lacks access to quality information. Only our regulators have access to the necessary customer level data that is critical when analyzing today’s microsecond markets. They should not try to outsource this research to others unless they are prepared to let them access this customer level data.
While we may have disagreed with Commissioner Piwowar in the above mentioned points, we did appreciate and agree with the following statements that he made which were critical of past SEC practices:
1) “However, I find it troubling that the SEC has still not conducted a comprehensive review of market structure in light of the 2010 flash crash. To the contrary, the SEC has effectively abandoned its Concept Release on Equity Market Structure that was published for public comment in January 2010. These are missed opportunities, and the Commission’s inaction needs to be remedied.”
2) “For example, we must question whether the market fragmentation and intermediation that many now decry as disadvantaging retail customers may be directly attributable to Regulation NMS. The Commission must be open to the possibility that any problems we identify are direct or indirect consequences of our own actions.”
3) “Rather, we should ask what incentives underlie the current market structure. What drives the supposed “need-for-speed?” Why are traders directing flow to so-called “dark pools” rather than “lit” markets? These are not easy questions, but they are threshold ones that we must tackle.”
We agree that something needs to be done in the equity market. But, unfortunately, investors can’t afford to be waiting years before a comprehensive review is concluded. Commissioner Piwowar did concede that modest, temporary changes like a pilot program for increased tick size should not wait for a comprehensive review but we would take this a few steps further. Pilot programs for both elimination of the maker/taker model and a modified trade-at rule should begin immediately. Our opinion is that the equity market does not need a multi-year, comprehensive review. We believe that just a few minor tweaks could restore investor confidence and eliminate much of the noise and predatory behavior that we see on a daily basis.