Survival of the Biggest
Why new regulations will help the big brokers
Traders Magazine, April 2010
"That which does not kill me makes me stronger." So wrote philosopher Friedrich Nietzsche in 1888, less than a year before collapsing in the streets of Turin and then not dying, but instead beginning a long mental and physical decline. Ten years later, the then-deranged man suffered a stroke, which also did not kill him, but left him unable to walk or even speak for the rest of his life.
Dan Mathisson
Despite Nietzsche's rapid invalidation of his own axiom, it lives on in the popular culture. The concept is inherently flawed for us members of the animal kingdom, plagued by innumerable things that do not kill us but that clearly don't make us stronger, either (Rickets, anyone?). Yet it is a phrase that regulators should keep in mind, because as new regulations are piled up, any that don't completely kill the big brokers will, in fact, make them stronger.
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Before I explain why this is so, let's look at the regulatory environment we find ourselves in. One small part of the reaction to last year's financial crisis has been a burst of new regulatory proposals for the stock market unlike anything since the 1930s. While angry bloggers rant about various inequities in equities, senators and congressmen barrage the Securities and Exchange Commission with letters demanding a variety of new rules.
As a result, there is a baby boom of rules going on. So far, we have new rules or official proposals on naked short-selling, sponsored access, flash trading, dark pool quoting, and the return of the uptick. A little less further along, a variety of new disclosures are gestating in the SEC's womb: new short sale reporting requirements, identification of dark pools on the tape, detailed position reporting for large trading firms and more. And finally, there are dozens of embryonic new rule ideas within the SEC's Concept Release issued in January. Not proposals yet, the 219 questions it contains about market structure topics appear to be a systematic effort to gather ideas from the Street for potential new rules.
New Rules Aren't Cheap
Some of these new proposals seem like sound regulations that will be beneficial for investors, while others may be harmful. Some of these proposals could have a major impact on trading, while others would barely affect the markets. But whether good or bad, important or trivial, all of these will have a material secondary effect: They will raise expenses for broker-dealers.
New rules, no matter how trivial, are not cheap for brokers. Firms need to pay for lawyers to study and interpret the new rules, technology teams have to implement system changes and buy hardware or third-party services, and traders and salespeople need to be educated. And that's the relatively cheap part-the big cost is that the firm needs to deal with the new rule and monitor compliance with it forever after. In its cost-benefit analysis of the new uptick rule that was announced in late February, the SEC estimated total implementation costs for the financial industry at the staggering sum of $1 billion, with ongoing maintenance costs of another $1 billion per year, in perpetuity until the rule is someday killed off. With many more new rules on the way over the next several years, individual broker-dealers should expect their ongoing compliance costs to increase by millions of dollars a year.
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