Why did the SEC form the Equity Market Structure Advisory Committee?
Jamil: The Committee was formed because Chair Mary Jo White and the SEC wanted a broader set of insights to help guide regulatory strategy. The SEC gets lobbied heavily, but it’s often difficult to tell if lobbyists are advocating on behalf of the financial industry or just their own narrow interests. This group provides an open forum to discuss a wide range of ideas for improving market structure as a whole.
How is the Equity Market Structure Advisory Committee structured?
Joe: There are 17 members representing a diverse range of views – including exchanges, large institutions, program trading, regulatory bodies, academics, the AARP, broker-dealers, wholesalers, and a former U.S. senator, among others. The first meeting was held on May 13th, and I thought we got off to a strong, substantive start.
Jamil: I’d say the composition is mostly right. The SEC itself noted the absence of representation from the retail broker-dealer community. For that reason, Joe and I put together a retail advisory council comprised of the five largest online retail brokers to ensure this community has a voice.
Joe: We want to keep retail brokers completely plugged into the process. We will meet with the retail advisory council before and after each SEC Committee meeting. I’d also encourage people to take a look at the website related to the Committee’s mission and work. The SEC has been very transparent about the Committee and the issues we’re examining.
Why does the SEC feel now is the right time for this Committee?
Jamil: Over the last 10 years, markets have gone through a sweeping transformation, resulting from advancements in technology and the implementation of Regulation NMS (National Market System). It’s a perfect time to revisit the overall regulatory structure and ensure it’s still relevant in today’s market. And the Committee structure is a great mechanism for delivering that holistic view. Without the Committee, the SEC would have a lot of individuals advocating their own interests in isolation. Having a representative group in the room together accelerates the conversation.
Joe: The Committee was formed at an appropriate time and everything is on the table. The SEC wants us to look at the whole industry; they want a holistic review. By definition, that’s going to touch everything, not just Reg. NMS. Really, the SEC wants to get the American people involved and play a part. The Committee is going to step through this piece by piece with the whole group, rather than just industry insiders. The timing is perfect and the idea is right.
Really, the SEC wants to get the American people involved and play a part. The Committee is going to step through this piece by piece with the whole group, rather than just industry insiders. The timing is perfect and the idea is right.
What is it the current state of the U.S. equities markets? What areas are most in need of reform?
Jamil: Citadel strongly believes that the markets work extraordinarily well. The U.S. equities markets are the envy of the world. And over the past 10 years, the markets have become better, faster and cheaper for both retail and institutional customers.
The U.S. equities markets are the envy of the world. And over the past 10 years, the markets have become better, faster and cheaper for both retail and institutional customers.
For retail investors, transaction costs are about two basis points after price improvement. So on a $100,000 trade, investor costs are about $20. That same trade in the corporate bond market would cost over $1,000. Imagine being able to buy or sell a $600,000 house with the transactions fees only being $120.
The SEC and the Committee members want to ensure equity markets remain competitive. It’s important to start with this premise. A few disgruntled market participants that have been displaced by advancements in technology argue that the market is broken. We’ve even seen a best-selling author put forward this idea. Frankly, these conclusions are not based on hard data or strong evidence.
We don’t believe the markets are fundamentally broken. People aren’t vulnerable to systemic harm or disadvantage. The question is not “how do we fix the equity market,” but “what could we do now that would lead to an even better market?”
The question is not 'how do we fix the equity market,' but 'what could we do now that would lead to an even better market?'
That’s a good segue into potential market structure reforms. From your vantage point, what are the most important areas for improvement?
Joe: At the end of the Committee’s first meeting, I suggested one reform I think is pretty easy to do: Devising a new set of transparency standards around order routing, and ATS (Alternative Trading System) venue operation to give customers more information about how their orders are handled. Any regulatory change that adds transparency to how order routing systems and market centers operate would be beneficial. Even as an exchange which is known for its transparency, BATS could provide more information about market execution quality. The standards in this area are outdated.
Second, access fees. Some people think these are broken. I don’t agree, but this is an issue that could be revisited.
Jamil: Joe is right. The market works extraordinarily well. From my point of view here are a few potential areas for improvement. First, the pricing of market data by exchanges. Exchanges have to file their pricing with regulators, but to some extent exchanges can charge whatever they want for data. Market centers have to pay up because they need the data to be in business. This gives exchanges extraordinary power and it should be regulated.
Second, Citadel has consistently called for enhancements to the market that enhance the integrity of the underlying operation of the markets. Kill switches are one important example that we have been advocating for some time. BATS has one. The extent to which we can make these mandatory, simple and consistent will make the markets safer. The obvious example of why kill switches are vital is Knight Capital. That type of error could happen again and there is no mechanism to stop it.
Citadel is an advocate for kill switches. BATS has one. The extent to which we can make these mandatory, simple and consistent will make the markets safer.
Finally, we’d like to see some reforms with the SRO (Self-Regulatory Organizations) statuses of exchanges. Exchanges have evolved into for-profit institutions, but they are classified as Self-Regulatory Organizations (SRO). I think the SEC should see if that’s still appropriate. And let me be clear, BATS is not the problem.
Joe, what’s your perspective on market data charges, kill switches and exchange regulation?
Joe: BATS historically has charged significantly less for market data and has been the primary competitive threat to NYSE and NASDAQ. Our broker fees are incredibly reasonable. While some may see us as a utility, we’re not a charity. We have to make money, but we’ve always provided a realistic perspective on prices and charged significantly discounted rates.
On kill switches, we completely agree. In fact, BATS was the first exchange to implement them back in 2012. In terms of reform, the most effective way to implement kill switches is to have the DTCC (Depository Trust & Clearing Corporation) keep track of growing capital limits and send data to exchanges in real time to shut firms off. It’s easy to imagine a situation where a firm has an issue across all four U.S. exchange operators and all 11 books and have that risk be spread out 11 times. It would be difficult for an individual exchange to assess the problem quickly enough. The one place things are happening in real time is at the DTCC.
With regards to SRO status, that’s a sticky topic. From a regulatory perspective, exchanges often provide a public good, not a private one. When we’re the center point for orders coming together and have to take an action on behalf of the entire industry to correct market anomalies, we have to take on very tough positions. That’s when immunity becomes essential, because the liabilities are so large. Without it, that could put exchanges in a perilous position. I’m open to discussion about SRO status, but the conversation needs to be holistic.
What other ideas were put forward at the Committee’s first meeting?
Jamil: The most common idea put forward was reducing access fees. Under Reg. NMS, the SEC put a cap on access fees – how much you can charge someone for accessing your quote. At the time, fees were set at .3 of a cent, which was considered de minimis. Many believe that fee is more relevant today than when it was enacted.
BATS has announced a great counter proposal. Instead of using the one-size-fits-all approach, we should switch to a more bespoke model. The most active securities, where there’s tons of liquidity, could see lower access fees. For others, fees might go higher. This approach would encourage people to post quotes and also improve liquidity.
Joe: Everyone agreed access fees should be examined. But it’s important to remember that exchanges are a business. We have costs, and we have to charge for our services. For the past 15 years, market-makers have had an incentive to post a quote out loud, for taking risk – it’s inherent in the way equity markets have worked for a long time. To say we should just get rid of that model doesn't make sense to me.
For the past 15 years, market-makers have had an incentive to post a quote out loud, for taking risk – it’s inherent in the way equity markets have worked for a long time. To say we should just get rid of that model doesn't make sense to me.
The other polarizing suggestion is that there should be a “trade at” rule – basically directing all liquidity to exchanges and saying dark pools can only execute if they price improve by half the spread or else they can’t participate in the national markets. I was frankly disappointed to see the “trade at” pilot the SEC put in place. It’s a pet idea among a minority of market participants.
The simple explanation for a “trade at” rule is that it would drive most trading back onto exchanges. Over the last 10- years we’ve seen a lot of trading move off exchanges. I have to give enormous credit to Joe and BATS for advocating on behalf of investors as a whole. “Trade at” would benefit BATS and all the exchanges. NYSE and NASDAQ are pushing it. But BATS is advocating for what they think is right for the market. I can’t overstate how important their voice is.
Can you tell us about the agenda of the May 13th meeting? Why did the SEC lead with the trade-through rule?
Joe: The SEC picked a good place to start. Market structure is such an interconnected topic, so the SEC purposely went to the heart of things – the competition of today’s market, which is supported by trade-through protection. It set us on a path to tackle issues in the right order.
Jamil: Originally when I saw the agenda, I was surprised the only agenda item was Rule 611, the trade-through rule. This was surprising because I believe that rule is one of the most important the SEC has ever enacted. The trade-through rule created competition among incumbent exchanges, and it drove a lot of the efficiency in the market. However, it soon became clear that the SEC was very supportive of rule 611, it was chosen not because the SEC was considering repealing it, but because it was an entry point to REG NMS; it led to a substantive dialogue about the heart of the issue – the competitiveness of the market.
How do you see the Equity Market Structure Advisory Committee progressing? Two years from now, how much change do you think the Committee will drive?
Joe: Change will proceed slowly, but the SEC has empowered this Committee to identify reforms that will further improve market structure. There will be meaningful work to address real issues. But success isn’t just making changes. Success can include reaffirming what we’ve done before. I’m hoping for a two-pronged outcome: A re-affirmation of what is working along with evolutionary improvements where they are needed.
But success isn’t just making changes. Success can include reaffirming what we’ve done before. I’m hoping for a two-pronged outcome: A re-affirmation of what is working along with evolutionary improvements where they are needed.
The U.S. equity markets are the envy of the world. The first responsibility of this Committee is not to jeopardize that status. Still, I believe there are a number of changes we can make to improve the market, so I’m hoping for an outcome along the lines Joe suggested.
What does it mean for your organizations to be involved in this Committee?
Jamil:I feel privileged that Citadel was asked to participate. We take seriously our responsibility as a leading participant in the marketplace to contribute to the policy debate and work constructively with our regulators and policy makers to continue to improve our capital markets and ensure that they remain the envy of the world.
I feel privileged that Citadel was asked to participate. It demonstrates that the SEC recognizes Citadel’s position in the marketplace, and it’s indicative of how much we’ve matured as a firm.
BATS grew up as an alternative to the entrenched monopolies, so we’ve been a force for positive change in the market since our inception. So years later being able to be part of this group is a proud moment for us and we take the responsibility of being on the Committee seriously. We will play an objective role, and that’s why Citadel and BATS are at the table.