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December 1, 1998

A Plea for Less Market Regulation: What Is an Exchange? The Automation, Management, and Regulatio

By Brandon Becker

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  • A Plea for Less Market Regulation: What Is an Exchange? The Automation, Management, and Regulatio

Ruben Lee is a long-time student of trading markets and financial intermediaries, both as business enterprises and as subjects of regulation. His work has focused on the changing competitive environment for the marketplace, and the effects such changes have on how markets govern themselves, generate information and are regulated.

Lee's most recent book is a comprehensive review of the various market-structure issues currently facing both the business people operating markets around the globe, and the responsible regulators.

In brief, Lee argues that there has been too much regulation of markets, and too little reliance on competition as a substitute for regulation. In his view, the increasing use of technology to facilitate trading allows for greater unbundling of the services traditionally associated with exchanges. Therefore, he argues governments should allow markets to compete with one another, and should rely on regulation to address only core issues of investor protection.

An understanding of Lee's approach to markets and their regulation first requires an appreciation of how his view of trading and quote information differs from the traditional American perspective. For more than 25 years, the widespread availability of real-time transaction and quotation information (what has come to be know as "market transparency") has been viewed by the Securities and Exchange Commission as a positive good.

Not only do the federal securities laws embrace the goal of increased market transparency, but the SEC consistently has argued that enhanced transparency improves investor protection, both by providing investors with opportunities to obtain the best price for their orders (i.e. best execution) and by improving the efficiency with which the prices of securities are determined (i.e. price discovery).

Based on these conclusions, or goals, the SEC has striven to increase the amount of trade and quote information publicly available. Indeed, much of the SEC's recent rulemaking and related enforcement activity can be viewed as a continuous effort to require market participants to disclose more fully their trades and quotes in an effort to avoid "hidden" markets.

In contrast, Lee does not believe market transparency is such an unadulterated public good. After a review of the varied economics literature regarding market microstructure, Lee concludes: "The view commonly held by regulators that the efficient-market hypothesis can justify regulatory intervention to achieve the dissemination of prices and quotes is false."

At the same time, however, he recognizes that the literature also does not support the conclusion that opacity is good. Rather, he concludes that the empirical evidence simply does not allow "any unequivocal conclusions concerning either the effects or the merits of transparency."

Based on his conclusion that the net advantages or disadvantages of increased market transparency are not proven, he argues that "market participants themselves should normally be left to decide the appropriate level of transparency." Specifically, he believes "price and quote transparency should be viewed as a mechanism that may or may not deliver the desired regulatory goals, rather than being seen as a regulatory objective per se. In most circumstances, it should not be mandated."