Industry Turf War Plays Out in D.C.
Traders Magazine Online News, December 19, 2012
Dark pools took jabs at exchanges. Exchanges took jabs at dark pools.
At a hearing of the Senate Banking Committee in Washington yesterday, exchange officials cast aspersions on alternative trading systems, or dark pools, while ATS executives criticized the regulatory structure supporting exchanges.
Representing dark pools were Dan Mathisson, Credit Suisse’s head of U.S. equity trading, and Bob Gasser, chief executive of Investment Technology Group. Representing the exchanges were Eric Noll, Nasdaq OMX Group’s head of transaction services, and Joe Mecane, NYSE Euronext’s head of U.S. equities.
Exchange executives told committee members that the sheer volume of trading done off-board was harming the price discovery process. They suggested that ATSs leaked information and needed to come under stricter regulation.
“The issue is whether the person who is setting the best price is properly incentivized,” Joe Mecane, NYSE Euronext’s head of U.S. equities, told committee members.
“A third of the time he will see trading happening at his price—executions that happen away from the public market. There is a diminished incentive for people to display orders publicly if a significant amount of activity happens in front of them.”
In his written testimony, Mecane claimed that 40 percent of the volume in over 3,000 securities was trading off-board.
Eric Noll, Nasdaq OMX Group’s head of transaction services, echoed Mecane. “Our concern is about the primacy of price discovery and price formation,” he said. “To the extent that those are being negatively impacted by current market structure, those issues should be revisited.”
Both Noll and Mecane also argued that the looser regulatory framework around ATSs was a weak spot in U.S. market structure.
“They don’t have displayed prices that are accessible by outside investors,” Noll said. “They are not required to take on all investors on an equal and fair basis. Their rules are not public. Their order types are not filed for a public notice and comment. There are some significant differences.”
Those differences lead to concerns over “asymmetrical information leakage,” fair access and discriminatory activities, Noll explained.
Mecane told the committee he wants to see the dark pools come under the same level of regulation as exchanges.
For their part, the ATS executives told committee members it was the exchanges that were in need of reform. They should be stripped of their self-regulatory status, which gives them benefits they don’t deserve such as immunity from liability and excessive market data revenues.
“We recommend that the SRO status of exchanges be examined,” Dan Mathisson, Credit Suisse’s head of U.S. equity trading, said in his opening remarks. “As SROs, exchanges have long been considered by courts to be quasi governmental entities and therefore entitled to the common law doctrine of sovereign immunity. But exchanges today are clearly not governmental entities. They are for-profit, private companies.”
Mathisson argued that if the exchanges were stripped of their SRO status they would operate in a more cautious manner, knowing they could be sued. Incidents such as Nasdaq’s Facebook snafu would be less likely to happen, Mathisson said.
Bob Gasser, chief executive of Investment Technology Group, agreed. “There has to be some consequence for a system wide failure of the type we experienced with Facebook,” he told the committee. “Our clients suffered. Other broker-dealers suffered.”
Much of the argument that exchanges should be relieved of their SRO status is based on the fact that they do much less regulating than they used, as they have outsourced most of the work to the Financial Industry Regulatory Authority.
For Mathisson, that means the exchanges don’t deserve the $400 million in tape revenue they receive every year. Originally, the purpose of those monies was to support the exchanges’ regulatory activities. But they spend far less than they earn, Mathisson told the committee.
The excess comes out of the pockets of brokers and investors, he said. He wants the regulators to take a “fresh look” at the system, which dates back to 1972. “Somewhere along the way, market data became a government granted windfall at the expense of the investing public,” he said.
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