"Solutions in Search of a Problem: Chair Gensler's Equity Market Structure Reforms."
Introduction
Chairwoman Wagner, Ranking Member Sherman, and esteemed members of the subcommittee, thank you for the opportunity to appear before you today to discuss proposed changes by the
My testimony today is focused on the changes the
As described below, the equity markets have changed in profound ways since Regulation NMS was adopted, but the rules remain largely unchanged. There is a demonstrated need, and an abundance of empirical support, as well as support by investors and industry commenters, to make targeted changes to these rules, to ensure they match the needs of the stock markets that exist in 2024, not those of an earlier generation. The proposals the
Background
Regulation NMS is a comprehensive set of rules that covers all aspects of trading in equity markets, most importantly in "NMS stocks," meaning those that are listed for trading on a national stock exchange. The core elements of that rule set include:
A standard "tick size," which sets the minimum price increments that markets can use to rank and display orders. The
The Order Protection Rule, which gave preference to exchange electronic quotations by giving them "protected quote" status, meaning participants may not trade at a worse price that is displayed on an exchange without first attempting to access that price.
A cap on the access fees that exchanges can charge to access these protected quotations. The cap was meant to prevent exchanges from exploiting their new status as protected quote venues by charging a high "toll fee" that was out of step with market pricing. The access fee cap was set at
New standards for the publication of consolidated market data, which provides a combined view of the best prices across all exchanges. These requirements left in place conventions which required that the displayed best prices show, in almost all cases, only quotes to trade at least 100 shares.
As we all know, the equity markets have been completely transformed in the intervening 19 years since Regulation NMS was adopted. At that time,
In light of these changes in technology and market dynamics, the
The Commission has very clear statutory authority to update these rules that have been in place for the last two decades.
Further, the NMS proposals are targeted at those aspects of the rules where the need for change is clearest. In making these proposals, the
The Basis and Substantial Support for Changes to Regulation NMS
The
First, the proportion of quoting in high volume stocks that occurs at prices that consistently run up against this minimum increment has grown enormously. Trading in such "tick-constrained" stocks now accounts for a clear majority of all share volume.
That means exchanges can't display prices in the increments where people want to trade. This undermines the ability of exchanges to compete against venues that are not subject to this restriction, and it also means the displayed quotes that all participants rely on are less accurate gauges of true market prices. As a result, the spreads between bid and offer prices are arbitrarily wider, costing investors money.
The
The
A broad cross-section of market participants, including IEX, overwhelmingly commented in favor of this alternative. The clear benefit of this approach is that participants would be able to see quoted prices that are much closer to the prices at which they want to trade. Another benefit to adding a half-cent tick size for some stocks is that the
Because of the clear benefits of this alternative, it was overwhelmingly endorsed by a wide range of commenters, including institutional investors representing around 25 trillion in assets under management.
Access Fees
As noted above, the access fee cap was meant to serve as a check against exchanges' charging rent-seeking toll prices to access their protected quotations. But the level of the cap was tied to the perceived market conditions in 2005. And because the fee cap was set at 30 mils, this rate has become pegged as the standard rate to access protected quotes.
For reasons similar to those affecting other aspects of the rules,
There are many reasons why a substantial and uniform reduction in the access fee cap of this magnitude is warranted.
First, alternative trading systems that offer the ability to trade with bids and offers on a continuous basis, like exchanges, but that do not benefit from having protected quotes, typically charge no more than 10 mils to access liquidity on their markets.
Second, high access fees distort the usefulness of displayed quotations. For stocks trading at the minimum
Third, institutional investors disproportionately bear the impact of high access fees because they often have to absorb those costs when they need access to liquidity on exchanges to meet their trading needs. That amounts to billions of dollars of added costs to the many millions of individual Americans whose savings are held by these fiduciaries. The added cost to access displayed quotes is also a factor driving institutional investors away from exchanges and towards other, less transparent venues which, again, harms price discovery.
Fourth, extraordinary advances in technology mean that exchanges are able to match transactions much more efficiently than was the case in 2005.
Finally, even those commenters who have objected to this specific change have generally acknowledged the fee cap could be reduced by half for those stocks that are given a narrower tick size - or a reduction of 50% for those stocks assigned a half-cent tick size.
But it is not clear why participants should be required to pay double - a penalty rate in effect - to access quotes in the great majority of stocks that would still be trading at the
Because of these clear benefits, virtually all institutional investors, who disproportionately bear the burden of high access fees, that have weighed in, along with many other participants, have supported a substantial, across-the-board reduction in the access fee cap.
Increasing Transparency of Exchange Fees
Today, most exchanges set transaction prices based complicated sets of rules governing fees and rebates charged or paid to individual brokers, such that it is difficult or impossible to determine what was paid or rebated on account of each individual trade. A main reason for the lack of transparency is the practice of determining prices for each broker and transaction based on the volume of trading the broker conducts during the month the trade occurs. That means determining the fees for each trade is necessarily a backward-looking process - it is impossible to know what net fees or rebates a broker was charged or was paid until well after the time the trade is completed.
In the NMS Proposals, the
This change would provide two big benefits. It would give more transparency so that market participants, including investors, can better evaluate the net prices charged for each trade. Also, where brokers sending client orders receive rebate benefits, this greater transparency means that institutional investors would have an increased ability to negotiate with their brokers for a return of those payments for their own accounts. Because of those benefits, this aspect of the proposals also received overwhelming support.
Implementing New Lot Sizes and Odd Lot Data
One way that markets have changed since Regulation NMS was adopted involves a large increase in the proportion of trading that occurs in "odd lot" amounts, those that are for less than 100 shares. This trend corresponds to the proportion of trading that is now conducted in high priced stocks, for which 100 shares can amount to a very large dollar investment. In fact, the average price of stocks in the Dow Jones Index nearly quadrupled between 2004 and 2019, and it increased another 18% from 2020 to 2022. Not coincidentally, odd lot trades account for more than half of all trades in the market today. Still, it remains the case that the consolidated data feeds that average investors use to see the best prices available only show quotes for at least 100 shares, even though odd lot quotes are often available at better prices.
In 2018, the
As part of its Regulation NMS proposals, the
There is No Reason to Delay
In fact, there is no reason to delay adoption of any of the specific changes described above. The
First, the data contained in broker reports is not needed to determine whether the changes to tick size, access fees, and other changes described above should go forward. Consistent with their purpose, the improved broker metrics will allow better broker comparisons based on how brokers perform under the rules of the road in place at the time. But there is no reason that the prior issuance of the new broker reports should drive decisions about how to update rules on exchange tick increments, access fees, and price transparency.
Further, there is an abundance of existing data that is relevant to and supports these rule updates. This includes, among other things, extremely detailed trade by trade and order by order data from market vendors, daily data produced by exchanges that is broadly available, data produced daily by the securities information processors, data on off-exchange trading that is produced by
For these reasons, the idea that new 605 reports must be fully in place and analyzed before moving ahead with other changes seems less like a reasoned argument than a calculated effort to stall any other updates.
Conclusion
It is often said the
The Commission has all the data, input, and rationale for moving forward with these changes to Regulation NMS, without delay.
ni See Securities Exchange Act Release No. 51808, 70 FR 37496 (
nii See Securities Exchange Act Release No. 96494 (
niii See IEX, "The Clock is Ticking on Equity Market Reform" (
niv See IEX comment letter of
nv See IEX, "
Read this original document at: https://docs.house.gov/meetings/BA/BA16/20240627/117468/HHRG-118-BA16-Wstate-RamsayJ-20240627.pdf
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