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February 1, 2011

Market Structure Calls

Eight Predictions for 2011

By Jamie Selway

Also in this article

With 2010 on the shelf, we offer our market structure thoughts for the coming year. As in years past, a reconciliation of last year's list with actual outcomes follows.

Limit up/down replaces circuit breakers. With industry support, the Securities and Exchange Commission works with exchanges to replace the current single-stock circuit breakers with a "limit up/down" structure that prevents trading beyond a certain threshold. Unlike futures markets, however, the equity flavor of limit up/down kicks to an auction if prices don't bounce off the limit after a brief pause. The current price threshold of 10 percent is lowered to 5 percent. In the interest of uniformity, NYSE relinquishes its "liquidity replenishment points," and Nasdaq mothballs plans for a "volatility guard." On the marketwide side, the current Dow-based halts at 10, 20 and 30 percent are replaced with S&P 500-based triggers at lower levels. The upshot: Between limit up/down and the new minimalist market-maker standards, markets close 2011 with insurance against the most aberrant aspects of last May 6's "flash crash."

 

Exchanges pursue internalization 2.0. With offboard trading stubbornly above the 30 percent share volume threshold, exchanges try a number of experiments designed to dislodge order flow--particularly retail--traditionally handled by wholesale market makers. These "internalization 2.0" efforts take the form of aggressive rebates for marketable orders, price-improvement schemes involving sub-pennies and rate cards that attempt to proxy for "toxicity." While the endeavors aren't wildly successful, flow providers are open to experimentation after poor performance by internalizers during the flash crash, and regulators offer quiet encouragement. We end 2011 with a modest downtick in trade-reporting facility (off-exchange) share.

Jamie Selway

 

Speed bumps for HFT. On the back of another year of controversy, the high-frequency trading community hits speed bumps. The increasingly crowded nature of many HFT strategies, coupled with a dearth of natural order flow and rising operational costs, culls the herd a bit. The desire to better regulate HFT is operationalized by FINRA and the SEC, increasing only perceived risks for most HFT actors, but presenting a real threat for the small minority of bad HFT apples. Industry calls for taxes on high levels of canceled orders gain traction and enjoy the support of regulators. A number of exchanges have them in place by year-end.