By Mark Schaedel, Principal, Vondelpark Capital
The SEC recently adopted a wave of US consolidated tape reforms to address “fundamental changes in the US market structure and the evolving needs of investors and other market participants”. Although the US Tape system has successfully stood the test of time, the underlying concerns are not new and have evolved over the last 20 years since exchanges demutualized. Meanwhile, European policy makers continue to struggle with the groundwork for a consolidated tape after more than a decade of consultation. ESMA continues to iterate on technical standards and continues to consult on Even as the European Commission prepares its legislative proposals to overhaul MiFID and pave the way for a tape, ESMA continues to run consultations on the detailed technical standards which underpin the MiFID that is being replaced. Now in the wake of Brexit, the FCA is racing to create the UK’s own consolidated tape framework.
As policymakers race to action, it is critical that they recognize the role that market data plays in today’s modern markets and establish clear objectives and an appropriate role for consolidated tapes going forward.
Cost continues to dominate consolidated tape discussions and preoccupy policy makers from developing clear conviction and policy objectives. This is not to downplay the importance of cost, but it is largely symptomatic and deeply embedded in broader market structure challenges. Cost has, and likely will, always be an issue as the importance and use of data only continues to grow. While competition has reduced explicit trading costs, fragmentation has caused the implicit costs of accessing liquidity and data from a broader spectrum of sources proportionally higher. Understandably, this comes at great frustration to an industry where entire business models are being challenged. However, the circular debates which ensue regarding IP ownership inevitably lead to stalemate and undermine the constructive dialog required for good policymaking and market structure evolution at a broader cost to the industry. Relative to other industries, innovation in capital markets has stagnated causing investors and issuers to seek alternatives in the likes of crypto markets and private equities respectively.
In response to the frustration, policymakers often fall into the trap of price regulation or otherwise seek to apply the conditions of “reasonable cost” which are inherently relative and subjective in nature. This is made even more challenging by the tendency for policymakers to conflate the needs of investors with broker dealers providing execution services which leads to flawed regulatory policy and further frustration.
Capital markets are complex data-driven ecosystems. Data has become a primary purpose for some market participants and is a critical source of competitive advantage. The sustainability of our capital markets requires that they are free to evolve. It may be that data revenues are a superior source of funding for markets due to the broad distribution base relative to transaction fees which are concentrated. While trade counterparties (and their ultimate customers) benefit from a transaction, the entire ecosystem benefits from the prices that are generated including derivative transactions, market indices, valuations and risk calculations to name a few. The tendency for market participants to believe that information should be free is shortsighted and ignores the economic principles that our markets now rely on. Many will argue however that a lack of competition causes these economics to fail. Fiduciary responsibilities and best execution rules require a virtually unlimited number of data products be obtained from any market trading eligible securities.
For investors, consolidated tapes provide a useful remedy to these challenges as a convenient source of comprehensive data coverage for a fixed cost which is designed to be broadly acceptable. Unfortunately, the laws of physics prevent these tapes from being useful sources of data for trading and execution purposes due to the latency associated with consolidation. The consolidated tape does however provide an important benchmark for accountability as it represents the worst price that an executing broker should achieve for their client using faster, more granular datasets.
Consolidated quotations have also been conventionally limited to the best bid and best offer from each market along with the overall best bid and offer as in the case of the US market NBBO. The amount of shares quoted at these best quotes are not likely to support the liquidity required with institutionally sized orders. For this reason, the SEC has proposed that orderbook depth be added to the US consolidated tape. Some stakeholders question if the cost of carrying and managing the large amounts of data associated with depth provides enough value to justify given the latency decay.
In Europe, a lack of a consolidated tape and ineffective trade reporting requirements have created fundamental challenges. While consolidated data products are broadly available, there is no common definition for the markets they cover resulting in inconsistent representations of the true market. Consolidated data users realize that even a comprehensive source of consolidated market data could be missing as much as 25% of the activity in any given security due to ineffective trade reporting rules. Market participants are forced to optimise the costs of consolidated data by selecting a reasonable subset of underlying market sources as a proxy for the broader market. The vendors of consolidated market data play a supporting role in order to make these products attractive, even substituting free sources of data or their own synthetic data where possible. In the case where consolidated data is provided to investment firms by their brokers, there is potential for conflict as the brokers could provide an even narrower range of sources to reduce the number of markets they are required to connect to leaving clients unable to account for better prices which may have been available elsewhere. These limitations and conflicts are often accepted by clients due to the explicit cost savings. Ultimately, these challenges undermine investor confidence and reduce market participation causing greater impact to the industry which outweighs any explicit data costs.
In both the US and Europe more than 50% of trades are now internalized by referencing prices from public markets while not participating in the public market at the expense of price and market quality. Besides the fact that the prices created by public markets no longer reflect the true supply and demand, the cost of referencing these prices is not differentiated from the cost of data for use in trading on the public markets. What’s more is the prices resulting from these internalized trades are sold back into the market increasing cost for market participants and creating noise in the public price feeds which do not distinguish these trades from those which represent liquidity that was publicly accessible. Fundamentally, the consolidated tape commercial model should recognize the relative value of the information provided by contributors. There is currently no mechanism that recognizes or rewards the relative value of the data contributions. Policymakers have the opportunity to align consolidated tape models to support the information value they create for investors and significantly enhance market transparency and sustainability of capital markets.
The convention of delayed data originated back in the 1970’s when ticker tapes could only operate at 10 characters per second. As markets moved faster, the delay was required to ensure that others did not receive the price information before the ticker tape users. The convention was retained for the display of last sale prices via display terminals, broadcast media and public ticker tapes although the needs of the public have now evolved and real-time prices can already be accessed from the likes of Google.
In today’s markets, the idea of delaying data by 15 minutes seems outdated. Yet in Europe, policymakers recently adopted the delayed data convention into law requiring that delayed data be free of charge. They applied the requirement to exchanges who have never applied the delay themselves as it was only used in displays which vendors make available from realtime feeds. MiFID rules also require this policy to be applied for pre-trade quotations across equities, bonds and derivatives. This policy backfired by limiting the commercial viability of any industry-led consolidated tapes from emerging. Particularly, in bonds where a 15 minute delay does not degrade the value of the product relative to realtime. A policy intended to provide universal access to data has inadvertently eliminated the prospect.
Investor confidence is critical to capital markets sustainability and should be the primary concern of all market stakeholders – especially regulators and policymakers. Objectives should be simplified and primarily focused on the needs of investors starting with the basic need for investors to gauge relative performance and hold agents accountable for their best execution responsibilities. More focus should be given to increasing information quality and aligning market structure to the evolving needs of investors by making markets more accessible and transparent. Tapes also provide opportunities to enhance support for passive investment trends which often introduce transparency risks for investors. Greater emphasis on index & ETF compositions, sector and ESG classifications promote investment universes, thematic investments and benchmarks which enhance performance attribution.
Lastly, from a European issuer’s perspective, the presence of a consolidated tape could provide an important vehicle for visibility outside local jurisdictions. With the majority of European issuers turning to bank funding and foreign sources of private equity, more urgency should be afforded to issuer needs.