By Adrian Griffiths, Head of Market Structure, MEMX
Few market structure rules have been as polarizing as the order protection rule, which generally requires that stock trades be executed at prices at or better than the national best bid or offer (NBBO). Recently appointed SEC Chairman, Paul S. Atkins, famously dissented from the adoption of the rule in 2005 along with fellow Republican Commissioner Cynthia Glassman, breaking with a Chairman from their own political party who ended up passing the rule with the votes of two Democratic Commissioners instead. With Chairman Atkins now at the agency’s helm, this debate is now back on the SEC’s regulatory agenda. On September 18, the SEC held a roundtable on trade-through prohibitions, starting a review process that many in the industry view as long overdue while others consider it potentially fraught.
While Chairman Atkins’ remarks at the roundtable made clear that he remains highly skeptical of order protection requirements — at the beginning of his prepared remarks he asserted that the existing rule “very clearly demands a course correction” — the views expressed by market participants were decidedly more mixed. Several panelists highlighted the benefits of order protection, including promoting investor confidence, incentivizing displayed liquidity, and preserving the integrity of the NBBO, which stitches together a number of disparate venues into one integrated marketplace. At the same time, other panelists focused on the rule’s unintended consequences, such as reducing best execution to a single variable, i.e., price, while facilitating market fragmentation and allowing certain exchanges to extract economic rents from their non-transaction services like market data and connectivity.
This dichotomy of views is not surprising when you consider the diversity of market participants present and the complex way in which order protection relates to other aspects of our market structure. While there are exceptions to every rule, retail brokers and their market making partners largely appear to support keeping order protection in place while addressing cost and fragmentation concerns though other means, such as amendments to the SIP revenue allocation formula. By contrast, institutional participants and proprietary trading firms generally seem to view the rule as limiting the trading strategies they can employ for their own trading or that of their clients, advocating instead for either full repeal of the rule or targeted exceptions like a market share threshold or exception for block trading.
As a member-owned exchange, MEMX is sensitive to both sides of this debate. A successful capital markets regulatory regime must continue to promote a strong NBBO. While this can certainly be accomplished with or without order protection, eliminating order protection will require down the line changes to promote innovation on our national securities exchanges. Indeed, innovation was a significant theme at the roundtable, with many panelists lamenting the lack of innovation on exchanges compared to other venues while others, including MEMX CEO Jonathan Kellner, maintained that the lack of exchange innovation is really a function of the SEC’s regulatory regime, including restrictive filing and fair access requirements that have already been relaxed for alternative trading systems.
In many ways the longstanding order protection debates goes to the very core of what it means to be an exchange in a modern electronic market where there is no shortage of competing venues vying for market share. As we explain in our own comments to the agency, exchange models are currently tuned to prioritize price because SEC staff has historically pushed back against more innovative mechanisms for attracting liquidity, including mechanisms that are allowed off-exchange in the U.S. or on-exchange in other foreign jurisdictions. If best execution is to shift away from price as the relevant benchmark, exchanges need be able to retool our offerings to meet the demands of our clients, and the SEC needs to open up its existing regulatory regime and make additional changes that allow that to happen.
The SEC along with its sister agency the CFTC is already considering how they can ease unnecessary compliance burdens for market participants, including currently unregistered digital asset exchanges. On September 29, the two agencies held a joint roundtable on regulatory harmonization, which Chairman Atkins and Acting CFTC Chairman Caroline D. Pham billed as necessary to promote continued innovation in U.S. capital markets. If the agencies are serious about promoting innovation, they will need to amend their rules to reduce unnecessary red tape for both existing participants and new entrants alike. This would provide a pathway for new financial products to be offered by new and existing markets within a framework that both facilitates innovation and ensures investor protection.
At the end of the day, MEMX is open to free market competition, which — if done right – can facilitate market evolution. However, if the SEC wants the market to evolve through competitive forces, rather than regulatory intervention, it has to make sure that this new framework promotes innovation and robust displayed liquidity on our securities exchanges. Whichever path the SEC decides to take with order protection, MEMX stands ready to work with the SEC and the industry to ensure that our broader capital markets regulatory regime continues to meet the needs of American investors. For additional thoughts on how this can be accomplished, please see our comment letter.
MEMX Comments on SEC Roundtable on Trade-Through Prohibitions
Few market structure rules have been as polarizing as the order protection rule, which generally requires that stock trades be executed at prices at or better than the national best bid or offer (NBBO). Recently appointed SEC Chairman, Paul S. Atkins, famously dissented from the adoption of the rule in 2005 along with fellow Republican Commissioner Cynthia Glassman, breaking with a Chairman from their own political party who ended up passing the rule with the votes of two Democratic Commissioners instead. With Chairman Atkins now at the agency’s helm, this debate is now back on the SEC’s regulatory agenda. On September 18, the SEC held a roundtable on trade-through prohibitions, starting a review process that many in the industry view as long overdue while others consider it potentially fraught.
While Chairman Atkins’ remarks at the roundtable made clear that he remains highly skeptical of order protection requirements — at the beginning of his prepared remarks he asserted that the existing rule “very clearly demands a course correction” — the views expressed by market participants were decidedly more mixed. Several panelists highlighted the benefits of order protection, including promoting investor confidence, incentivizing displayed liquidity, and preserving the integrity of the NBBO, which stitches together a number of disparate venues into one integrated marketplace. At the same time, other panelists focused on the rule’s unintended consequences, such as reducing best execution to a single variable, i.e., price, while facilitating market fragmentation and allowing certain exchanges to extract economic rents from their non-transaction services like market data and connectivity.
This dichotomy of views is not surprising when you consider the diversity of market participants present and the complex way in which order protection relates to other aspects of our market structure. While there are exceptions to every rule, retail brokers and their market making partners largely appear to support keeping order protection in place while addressing cost and fragmentation concerns though other means, such as amendments to the SIP revenue allocation formula. By contrast, institutional participants and proprietary trading firms generally seem to view the rule as limiting the trading strategies they can employ for their own trading or that of their clients, advocating instead for either full repeal of the rule or targeted exceptions like a market share threshold or exception for block trading.
As a member-owned exchange, MEMX is sensitive to both sides of this debate. A successful capital markets regulatory regime must continue to promote a strong NBBO. While this can certainly be accomplished with or without order protection, eliminating order protection will require down the line changes to promote innovation on our national securities exchanges. Indeed, innovation was a significant theme at the roundtable, with many panelists lamenting the lack of innovation on exchanges compared to other venues while others, including MEMX CEO Jonathan Kellner, maintained that the lack of exchange innovation is really a function of the SEC’s regulatory regime, including restrictive filing and fair access requirements that have already been relaxed for alternative trading systems.
In many ways the longstanding order protection debates goes to the very core of what it means to be an exchange in a modern electronic market where there is no shortage of competing venues vying for market share. As we explain in our own comments to the agency, exchange models are currently tuned to prioritize price because SEC staff has historically pushed back against more innovative mechanisms for attracting liquidity, including mechanisms that are allowed off-exchange in the U.S. or on-exchange in other foreign jurisdictions. If best execution is to shift away from price as the relevant benchmark, exchanges need be able to retool our offerings to meet the demands of our clients, and the SEC needs to open up its existing regulatory regime and make additional changes that allow that to happen.
The SEC along with its sister agency the CFTC is already considering how they can ease unnecessary compliance burdens for market participants, including currently unregistered digital asset exchanges. On September 29, the two agencies held a joint roundtable on regulatory harmonization, which Chairman Atkins and Acting CFTC Chairman Caroline D. Pham billed as necessary to promote continued innovation in U.S. capital markets. If the agencies are serious about promoting innovation, they will need to amend their rules to reduce unnecessary red tape for both existing participants and new entrants alike. This would provide a pathway for new financial products to be offered by new and existing markets within a framework that both facilitates innovation and ensures investor protection.
At the end of the day, MEMX is open to free market competition, which — if done right – can facilitate market evolution. However, if the SEC wants the market to evolve through competitive forces, rather than regulatory intervention, it has to make sure that this new framework promotes innovation and robust displayed liquidity on our securities exchanges. Whichever path the SEC decides to take with order protection, MEMX stands ready to work with the SEC and the industry to ensure that our broader capital markets regulatory regime continues to meet the needs of American investors. For additional thoughts on how this can be accomplished, please see our comment letter.
