The Reg NMS II Debate Begins

And so, it begins.

The debate around the Securities and Exchange Commission’s recently announced Regulation National Market Structure (Reg NMS ) II proposal is getting ready to begin. Much like the 700 plus page opus on equity market reform that the market digested over 15 years ago, this new 595 page examination and reformation of the bedrock principals governing the market are shaping up. This week saw the end of the public comment period for the proposal but not the debate, which will go one for some time.

Nasdaq recently filed its comment letter on the proposal in which it writes the SEC fails to recognize, and thus insufficiently analyzes, how the Proposed Rule (Reg NMS II) would essentially rewire the equity markets. The operator noted the magnitude of the proposal and felt all things market structure should be taken into consideration when discussing the proposal – not just market data, costs of data and its provision – as many have focused on and given attention to.

Dan Royal, Janus Henderson

Dan Royal, Head of Global Equity Trading at Janus Henderson told Traders Magazine that data is indeed one of the areas he is focusing on. And regarding market data, the current information dissemination via the Securities Information Processor (SIP) has not kept pace with the broader market and technological advances, in his opinion.

“The informational content needs to be improved and the geographical latency concerns need to be addressed for the consolidated feeds to be competitive,” Royal said. “Reducing some of the information asymmetries between participants is a step towards a more level playing field of data consumption.”

And while Royal and the buyside are looking at data among other things, the proposal requires a thorough in depth examination of all the issues, as Nasdaq noted.

“The Proposal is also about quotation display, locked and crossed markets, round lots, order protection, and best execution – all of which the Commission studied at length when it proposed, re-proposed, and then adopted Regulation NMS in 2005,” Nasdaq commented. “The Proposal gives short shrift to the intricacies, market dynamics, and interdependencies that characterize the U.S. equity markets and determine how they operate and perform over time.”

Contrary to Nasdaq, Hitesh Mittal, CEO and Founder of BestEx Research, said that prima facie the proposal is to be lauded despite its focus on data provision and the SIP. Mittal said the proposed changes will improve liquidity in all stocks by using a more economically meaningful lot size and lowering information asymmetry among market participants.

Hitesh Mittal, BestEx Research

“Overall, we applaud the SEC’s robust proposal,” Mittal said. “The proposed changes will improve liquidity in all stocks by using a more economically meaningful lot size and lowering information asymmetry among market participants. While the proposal could have negative effects on the profitability of exchanges and market makers, we believe that investors win with a proper implementation of this proposal.”

One valid point all interviewed for this article agree on is the need for caution and not pushing through rulemaking that would have more unintended consequences than it attempts to solve. Nasdaq makes no bones when it wrote “the Commission, in an apparent rush to finalize the rulemaking in the midst of a pandemic, rejected several reasonable requests from brokers, issuers, exchanges and other concerned market participants for an extension of the 60-day comment period so that commenters could have adequate opportunities to weigh in on the totality of the Proposal while also struggling for economic survival.”

To prove its point, Nasdaq noted that during the comment period, nearly 100,000 Americans have lost their lives and 40 million have lost their jobs due to COVID-19. Within this context, that as of the day before the comment period expired for Reg NMS II, the SEC received only 14 comments, or four percent of the number of comments it received as of the day before the comment period expired for the original Reg NMS.

Reg NMS II looks to address market structure inefficiencies and suggests:

  • Creation of Multiple SIPs
  • Eliminate the Unified NBBO
  • Expand “Core” Data
  • Create “Round Lots” of Fewer Than 100 Shares
  • Require Order Display Without Protection

Jack Miller, Head of Equities at Baird agreed with Nasdaq. He said that Reg NMS is probably the defining market structure event of the last generation and it’s no surprise that the stakes for NMS II are high. While NMS ‘leveled the playing field’ in many ways, it also paved the way for the electronification, fragmentation, and complexity that define our current market structure. While the industry has largely adapted, new concerns have emerged and NMS II is an opportunity to address some of these “pain points.’

Jack Miller, Baird

“Among them is market data,” Miller told Traders Magazine. “In substance, NMS II is largely about market data and the SIPs, but in concept it is about fairness.  To create a ‘National Market System’ there must be a definitive data source for the market for a security is that is essentially a utility for the use of market participants.  Does this utility meet the needs of market participants?  Is it priced fairly?  Are alternatives necessary?  And perhaps more pointedly, can a system where the same market participants who control the content and quality of the utility also control the alternatives be considered fair?”

And while the suggested changes to data and the SIP go a long way toward addressing the last question without being overly prescriptive regarding the solution. Beyond that, however, Miller said the devil is in the details.

“The introduction of the competing consolidator model introduces the additional concept of competition to maintain fairness in the consolidation and dissemination of market data,” he said. “ Fostering competition a medicine against abuse of monopolistic power feels a lot like … Reg NMS … and could lead to some of the same side effects, including fragmentation.  Do we really want a fragmented SIP?  Is this just shifting the speed arms race to a different corner?”

Miller, like others, admitted to not having the answer to all of the aforementioned questions but, as eager as he and others we are to take action given the years of debate, it feels prudent to allow the new operating committee governance structure a chance to address some of these issues, which is, after all, the purpose of that change.

“In the end this may be the determinant of whether we have a new and improved Reg NMS or a true “NMS II” – with all the baggage that entails,” Miller said.

This article originally appeared in the June 2005 edition of Traders Magazine

Making Sense of Reg NMS

Lawmakers will be closely examining the recently approved Reg NMS, which contained the extension of the trade-through rule to electronic markets. They promise to hold oversight hearings. Some lawmakers continue to criticize Reg NMS.

Nevertheless, no member of Congress, speaking to the recent STA Congressional Conference, called for the immediate reversal of the SEC’s controversial three to two vote.

“It will certainly require some highly vigilant oversight. It will require much scrutiny,” said Rep. Richard Baker (R-La), the chairman of the House Subcommittee on Capital Markets.

Previously, Baker has branded the trade-through rule a relic that should be junked. Still, in the wake of Reg NMS passage, he has promised hearings. Other lawmakers also remain suspicious of NMS.

“I’m very concerned with this. We run the risk of discouraging trading competition between exchanges,” according to Senator John Sununu (R-NH), a member of the Senate Banking Committee. He has been a critic of the trade-though rule.

Sununu complained of “a tilt” in favor of the New York Stock Exchange. “Members of Congress should take a hard line on the rule,” Sununu replied when asked by Traders Magazine if Congress might consider an override of the commission’s decision.

Privately and publicly most congressional members were critical of the rule extension, but they hedged their critical comments. They said that they have to see the exact terms of the rules as they will be translated by the staff of the SEC. The Reg NMS plan-a complex measure covering four major areas of market structure-hadn’t been printed in the Federal Register some four weeks after approval by the SEC.

When Reg NMS was passed several lawmakers issued critical press releases, intimating that they might try to override the SEC’s action. However, at presstime, no lawmaker had commited to offering an override bill. Spokesmen for members of Congress have emphasized that they need to go over the order in the Federal Register line by line. They have also said that they want to see how the industry reacts to the new rules before they take any action in Congress. The debate may continue for some time because there is much to read, interpret and put into rule form.