Regulations

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The industry might have rung out 2014 discussing the “grand compromise” on the US equity market structure led by the Intercontinental Exchange that would lower access fees in exchange for a trade-at rule, but BATS Global Trading wasted no time in the new to offers its market-structure alternative.

In an open letter to the industry, exchange CEO Joe Ratterman and president Chris Concannon argue against the compromise as a bad deal for investors despite it being a win-win for exchange operators and broker-dealers.

“[I]nvestors will likely pay more both in the form of potentially wider spreads as well as fewer and inferior execution choices resulting from restrictions on competition,” they wrote.

The pair suggests that exchanges should determine their access fees, and associated rebates, using a tiered price model based on an issue’s liquidity. For example, the most liquid stocks could have a five cent per 100 share, or $0.0005 per share, and more illiquid a stock is, greater its access fee.

They also recommend that alternative trading system (ATS) operators be required to disclose the operation rules of their platforms, descriptions of available order types, transparent eligibility guidelines, participant pricing tiers, order routing logic, and eligible routing destinations as well as expanding Rule 605 and 606 reports to include execution quality on a dealer-by-dealer basis.

None of these ideas are a real departure from the industry’s ongoing market-transparency and market-structure conversations.

What is new, is their idea of stripping Regulation NMS trade-through protection and shares of the consolidated tape revenue from any self-regulator organization (SRO) or publicly displayed ATS that does not achieve more than one percent of the daily consolidated tape volume over a rolling three-month period.

The current Regulation NMS structure artificially subsidizes competition and encourages further market complexity since it costs existing exchange operators almost nothing to mint a new exchange while broker-dealers could face substantial cost connecting to the new venue, Ratterman and Concannon argue.

Which exchanges would be affected?

According to the latest Tabb Liquidity Matrix, November 2014, the immediate losers would be NYSE MKT, Chicago Stock Exchange (CHX), and Nasdaq PSX, which have a 0.3%, 0.4%, and 0.7% market share respectively.

The market shares for the four equities exchange that BATS operates are well above the proposed 1% threshold – BZX (7.7%), EDGX (6.1%) BYX (3.1%), and EDGA (2.1%).

If the Securities and Exchange Commission implements this regulation, it would liberate about 1.4% of current liquidity, which the remaining exchanges would divide. However, it would remove three protected quotes that help tighten the overall spreads.

Additionally, it would raise a significant barrier-to-entry for potential new exchange operators if they needed to capture 1% daily volume within the first quarter of their operation to receive trade-through protection.

Competition always breeds innovation and stripping away the trade-through rule for the smallest exchanges guarantees that the US equities markets will remain a triumvirate.

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The era of good feelings definitely is over for the over-the-counter (OTC) derivatives market judging by the tone of the conversations at yesterday’s SEFCON V.

“It’s to be expected,” said  a beaming Chris Ferreri, chairman of the Wholesale Brokers’ Association Americas (WBAA) and who hosted the event. “Last year, we all were trying to accomplish the same thing. But with ‘made available to trade’ in place, we are all competitors now. Isn’t great?”

The zingers flew wild and free during the conference’s first panel on what the industry has learned over the first year of swap execution facility (SEF) trading.

Representatives from Bloomberg, Credit Suisse, the DTCC’s Data Repository, Thomson Reuters,  tpSEF and UBS shared some rather candid thoughts and information during the verbal free for all.

Although the UBS offers a SEF aggregation service, it currently does not connect to Bloomberg SEF or tpSEF.

And when it comes to differentiating the SEFs that have sizable liquidity, it is all about the bells and whistles that they offer, according to Bloomberg’s Nathan Jenner and Thomson Reuters’ Jodi Burns.

However, the SEF operators might want to cool their technology pitch to swap dealers and institutional investors, suggested PIMCO’s Ric Okun, who spoke on a later SEF-technology panel.

The rest of the day’s discussions addressed the future of cleared foreign-exchange (FX) non-deliverable forwards (NDFs) and the benefits and shortcomings of central limit order book (CLOB) versus request for quote (RFQ) execution.

When an audience member asked Commodity Futures Trading Commission (CFTC) Chairman Timothy Massad whether the regulator developed a sense when NDFs would be available to trade, Massad stated that the CFTC “has not taken a view on it yet.”

Whether it will be before 2017, when the EU’s rules should go into effect, no one knows.

At least the one panel, which consisted of representatives from BGC Derivatives Markets, Bloomberg, Squire Patton Boggs and London-headquartered Wholesale Broker Market Association (WMBA), came to a consensus that NDFs probably will clear like US dollars and euros. They bandied about an 80-20 ratio, but could not agree on which currency represented which percentage.

The most heated conversations, unsurprisingly, related to CLOB and RFQ execution models. It definitely is the Mac versus PC and open-sourced software versus licensed software debate for the industry.

Supporters of RFQ won the day in terms of their loudness and liquidity, but consider the membership of the WBMAA.

CLOB supporters were optimistic that liquidity on their systems would pick up when interest rate volatility and its related volume returns to the market.

They also believed that as swaps dealers widen their RFQ spreads due to regulatory capital restraints, that it may drive investors to the CLOB platforms.

It is not clear if there will be a SEFCON VI, but the OTC industry still has a lot to do in terms of data consistency and quality, according to the DTCC.

A standardized instrument symbology across all SEFs would be a good place to start, suggested KCG’s Isaac Chang.

 

 

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The Securities Industry and Financial Market Association (SIFMA) published its recommendations for changes to the US cash equities market structure that promises enough pain for broker-dealers as well as exchanges and alternative trading system operators.

Since reporting on it earlier this week, I am still trying to wrap my brain around the impact SIFMA’s proposed changes would have if the market adopts them.

Besides implementing kill switches, expanding the reporting requirements to the Financial Industry Reporting Authority and reducing/eliminating maker-taker fees, SIFMA recommends that the securities information processors (SIPs), the organizations that gathers all of the market data for NYSE- and Nasdaq-listed stocks from each exchange and reporting facility and aggregates it into consolidated feeds, should first update their data processing infrastructures “so that the SIPs provide the fastest commercially available services for data aggregation and distribution.”

After the SIPs make the necessary upgrades, SIFMA suggest throwing all of it out- baby, bathwater and all- in favor of having it replaced by competitive vendors, which would replace the SIPs with their own aggregated offerings. It would be similar to how the US Securities and Exchange Commission (SEC) retired the out-date Intermarket Trading System (ITS) in favor of private direct links between exchanges as part of its 2005 Regulation NMS market reforms.

Besides being an industry owned and operated market utility, that is where the similarities between the roles of the ITS and SIPs end. The ITS was a network, whose function easily could be replaced with another network provider. The SIPs are not just making an aggregated market data feed. They are making THE aggregated market data feed. You know, the one to which the regulators always refer.

Take that away then what will take its place?

Aggregating market data is not a clean business. It needs to be scrubbed and have any data outliers addressed. It is not possible for two market data aggregators to deliver feeds that are completely consistent tick by tick, much less half a dozen of them.

This is not to say that the SIPs have implemented the perfect method to aggregate market data feeds. They have not, but at least they are industry owned and not operated as for-profit businesses, which makes them perfect as the objective record for the market.

Any other arrangement would open up a regulatory can of worms.

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According to comments made by US Securities and Exchange Commission (SEC) Chair Mary Jo White during today’s annual SIFMA meeting, the industry should not expect regulatory oversight easing any time soon.

White expects the regulator to continue its use of “aggressive tools” like wire taps and stings to discover evidence of fraud. However, budget restraints will be an ongoing restraint in their use.

When asked about the SAC Capital Advisors settlement, she said that although it happened before she came to the SEC, she believed it was the right. White declined to comment on the current regulatory issues faced by SAC’s Steven Cohen since she might be sitting in judgment of him in the future.

More to come.

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Javelin SEF is the first swaps execution facility (SEF) operator to submit a list of potential instruments that the electronic trading platform would like to “make available to trade” to the US Commodity Futures Trading Commission (CFTC), Bloomberg’s Silla Brush reported on October 19.

Greenwich Associates’ Kevin McPartland, who is quoted in the story, offers expanded analysis in a blog post of his own.

It’s not surprising that an all-electronic operation like Javelin was the first to break the surface tension with such a broad instrument list since it has no interest of keeping these transaction voice-based.

The CFTC has 90 days to decide whether to approve or reject Javelin SEF’s list. If it does not extend its decision deadline, traders will be required to execute trades for dollar-, sterling- and euro-denominated interest rate swaps on SEFs starting in mid-January 2014.

The regulator also started the clock ticking on a 30-day industry comment period for the SEF’s list that began on the filing date and, hopefully, will provide interesting opinions.

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