January 21, 2010

Seven Signs for 2010

Market Structure Predictions

By Jamie Selway

The market closed the books on 2009 in early November, but predictions for the new year trade on a calendar basis. Below are ours for the market structure landscape, followed by settlement (T+365) on last year's list.

1. Dark Pools Get Guardrails. Last May, the SEC announced an end to the "Sirri Doctrine"--a laissez-faire approach to dark pools--and said it planned to address some concerns. Initially expected to take the form of a concept release, but hurried by politics and the press, the SEC proposed three rule changes in October. Two of these--equating an "actionable IOI" with quotations and reducing the Reg ATS display threshold from 5% to 0.25%--are approved. The third, real-time tape illumination of dark trades, is shelved in favor of end-of-day, stock-specific, volume disclosure. Also proposals to make public Form ATSes, and amendments thereto, are considered and accepted. Fair access prompts a fight, but no changes are made. NYSE proves a better partner than Nasdaq as a real-time source of aggregate volume information for individual dark pools. The upshot: less mystery, more rule of law, and no unreasonable new burdens.

2. Internalization: Once More Unto the Breach. Related to the dark pool efforts, the SEC raises the issue of a "trade-at" prohibition for off-exchange venues. Positioned as a policy question--do "dark" executions harm market quality by reducing the incentive to display?--the deeper issue is a Grasso-era commercial chestnut: exchanges versus internalizers. As it has multiple times in the past 35 years, the SEC rejects requirement that off-board venues provide price improvement. When the SEC bans "flash" orders-which are really just an extension of internalization--DirectEdge asks to change its ELP "jump ball" into a 30-millisecond price-based auction, raising the question of subpenny orders anew.

Jamie Selway

3. How High's the Frequency, Kenneth? The ever-inflating buzz around high-frequency trading--66%, no 70%, no 120% of volume! Twenty one billion dollars in annual profits!--cools as regulatory attention heats up. Exchange co-location is rightly left alone; "naked" sponsored access goes away via exchange and FINRA rules, as well as the continued migration of high-frequency firms to broker-dealer status. Market surveillance tools and techniques play catch-up. This means few actions against high-frequency types. The current binary view of the world--high-frequency is either the second coming or the cause of cancer--is resolved with a realization: while clearly good for liquidity in the aggregate, even high-frequency firms succumb to human frailty on occasion. Better information, understanding, and surveillance--as opposed to blunt policy change--is the chosen remedy.