In recent debates centering on market structure the issue of choice for investors and other market participants is often not a prominent part of the discussion. Economic choice is vital to healthy markets, because without it, innovation and price competition suffer.
Securities and Exchange Commission (SEC) Chairman Mary Jo Whites recent speech before the Security Traders Association regarding the path forward on equity market structure recognized the powerful role of competition in the markets. Chairman White also correctly identified several fundamentals of equity market structure: the importance of technology and operational integrity; the need to test assumptions about market structure; and the need for regulatory decisions to be based on empirical data.
As some voices calling for various market structure changes have grown louder, it is encouraging that the Commission will strive to base its regulatory decisions on empirical data. Such data is critical in examining the impact potential market structure changes, whether increasing tick sizes on certain publicly traded companies or restricting off-exchange trading, would have on investors.
Several data points are already abundantly clear: retail investors have never had it better in terms of commission rates (cost) and the speed and quality (both in terms of price and fill) of trade execution. Investors also have at their fingertips the trading tools and technologies that merely a few years ago were only available to professional traders.
While this does not mean that the current market structure is perfect, there is a big downside if the solutions are wrong and damage the investor experience. Any analysis of potential changes should recognize the current market structure benefits to investors and question whether current or future market structure proposals are being promoted to solve business model problems at the expense of investor choice and competition.
Tick Size
A pilot program to increase the quoting increments of smaller company stocks deserves attention, but should policymakers move forward, we urge caution in how it is constructed. Any pilot program should set clear goals at the outset. It should be limited in scope and duration in order to measure whether it benefits not only the listed companies but also investors. Investors will want to know if they are paying more for the same trades, including whether an increase in spreads might be offset by increased fill rates or other forms of price improvement.
The construction of a pilot program is important. If done incorrectly, a pilot will not yield usable results.
First, a pilot program should not include any market structure changes. It should be consistent with the current market structure rules with the one exception of increasing the quote increment. If any additional changes are made in a pilot program, it will be much more difficult to isolate whether the data coming from the pilot are the result of the change in tick size or the other changes. Second, the pilot program should not allow companies to opt-in or opt-out and must not be adjusted mid-stream. The pilot must have a control group and an experimental group and be blind for real data to be collected. Third, the pilot should be finite in length, but be for a minimum of two years to ensure that it captures different types of market conditions.
Trade-At and Other Limitations to Off-Exchange Trading
While some market participants are still promoting a trade-at rule and other proposals that would limit dark or off-exchange trading, it is important to ask what problem this solves. One can argue that these proposals may solve certain business model problems, but it is critical that they be examined as to their impact on investor choice and competition. A dynamic and competitive marketplace of different business models vying to attract order flow benefits the markets and the investing public. TD Ameritrade uses competition between all types of market centers and constantly measures their performance to make sure that its order routing for clients achieves the best execution possible. The performance of these market centers is measured by looking at metrics such as speed of execution, price improvement possibilities, and fill size, which are the characteristics our clients measure us by. If this competition were to be limited, it would also limit choices for all investors. Reducing competition is not a formula for improving these trade execution measurements.
We do not need to look far to see the impact of a trade-at regime. The Canadian experience since the October 15, 2012 implementation has resulted in 50 percent higher execution costs, 50 percent less price improvement since October 2012 until it dropped another 20 percent after the IntraSpread volume collapsed and some more choice eliminated, according to data from TD Securities. Bottom line: dark volume is down significantly and investors are paying more.
Tax Issues
Turning to tax issues, the Financial Transaction Tax (FTT), which is now being implemented by Italy and France, decreases liquidity and raises the cost to all investors. Data shows that the FTT will not raise as much revenue as projected. For example, in France the FTT has raised less than 40 percent of the revenues it was forecasted to raise in the first four months, according to Bloomberg. It does not appear that U.S. policy makers are pursuing an FTT, and the results in Europe should reinforce the notion that it would be harmful to U.S. markets.
Ways and Means Chairman Dave Camp (R-MI) issued a Financial Products Discussion Draft earlier this year which if implemented, would severely impact options investors, as it would decrease the ability of individual investors to hedge. It would do so by causing the underlying cash position to be taxed, if a put or call is written on that position. Most options are already short term (82 percent are three months or less), so requiring mark to market at end of year would add greater complexity with no material gain for tax collectors. We also need to realize that options trading is not only for the rich as the average account to deploy these strategies is under $80,000, according to data from TD Ameritrade.
Tax reform should not include policies that would increase the cost of an important tool for individual investors to hedge their investments.
Whether it is securities law or tax policy, investors are best served when there is competition and choice available.
Paul Jiganti is managing director for TD Ameritrade. Working in the firm’s Chicago office, he is responsible for market structure and routing strategy.
