Responses To Proposed Dark Pool Regulation
From Senator Ted Kaufman:
Two months ago, I wrote a letter to SEC Chairman Mary Schapiro calling on the SEC to undertake a comprehensive “ground up” review of the U.S. equity market structure, including dark pools, high-frequency trading, flash orders, co-location of servers at the exchanges, direct market access, liquidity rebates, and payment for retail order flow. Today’s open meeting and rule proposals on dark pools, coupled with the proposed ban on flash orders issued last month, demonstrate that SEC Chairman Mary Schapiro and the Commission are taking this review seriously.
I support the three amendments to the rules outlined by the Commission today, in that they are consistent with suggestions I have made in the past to address dark pool concerns: defining indications of interest as quotes, lowering threshold limits on dark pools, and stricter reporting requirements. We need a comprehensive review, but that should not prevent the SEC from moving forward to adopt obvious improvements supported by evidence.
At the same time, these issues cannot be considered in isolation, as we already face systemic market structure problems resulting from the unintended consequences of prior rules. The growing volume in dark pools itself, for example, is an unintended consequence of Regulation ATS. Every time the Commission squeezes one side of the balloon, a bulge appears on the other side. The SEC must be conscious of those effects as well.
Banning flash orders and imposing limits on dark pools should not be the end of the story, nor should they be seen as sacrificial lambs offered up by a substantial majority of Wall Street players as the price to ward off deeper review.
Chief among the systemic issues that must be carefully reviewed is high frequency trading, which now makes up over 70% of the daily market volume. The SEC needs to closely review these strategies -- whether employed in dark pools or the public markets -- to ensure that high frequency traders are not able to take advantage of the long-term investors who are the backbone of our capital markets. It is the SEC’s mission to protect long-term investors, who care about the valuations of the underlying companies, not those who quest for trading profits achieved in milliseconds.
As I have said frequently, I’m all in favor of liquidity in the markets – but when it works against transparency and fairness, transparency and fairness must win. As a Commission staffer said at today’s meeting in response to a Commissioner’s question: spreads have narrowed, but prices quickly move back and forth, and high-speed professional investors are better able than retail investors to take advantage of those price impacts.
Moreover, I’m deeply concerned that high frequency trading, left unchecked, could develop into a systemic risk, becoming simply too big and too fast to regulate. Direct access to the exchanges by hedge funds -- which still are unregulated entities and which employ high frequency strategies without even the checks associated with rules applicable to broker-dealers -- also increasingly jeopardizes systemic stability.
Achieving effective and efficient regulation of these profit-maximizing strategies will not be easy. Already many industry participants have opposed even a mere review of high frequency trading. Their position seems to be “nothing to worry about, move along.”
Given all we know about recent history, we cannot blindly accept these assurances. I hope the SEC will continue to press for meaningful reforms, and so I’m pleased that Chairman Schapiro at today’s meeting mentioned these issues as important to the Commission’s review. When the news reports that even sophisticated institutional investors are asking their major broker-dealers “not to simply hand over their orders on a silver platter” to high frequency traders, we know clearly that investor confidence in the fairness of the market has been jeopardized.
Our credit and equity markets should be a national treasure. They should direct capital to its highest uses – profitable, job-creating investment, not opaque, fast-buck speculation. We need a careful review of high frequency trading, dark pools and other practices in a comprehensive “ground up” review of how our equity markets function. Only then can the SEC restore investor confidence, establish a level playing field for all investors, protect the public from another systemic failure, and secure the foundations of our economic future.
And the response from Themis Trading:
We believe the SEC is striking an appropriate balance by shining a light on so much of the murky and small-execution size dark pools, and forcing their flow to the public quote, while still acknowledging the role of block trading and innovation for the institutional and retail community alike. We also appreciate the SEC looking broadly at our market structure as it exists today, and broadly looking at issues like co-location, specifically in how it relates to unfair advantages in the delivery of market data. We expect overall liquidity to not be materially affected, and perhaps the spreads even tighten, especially in the lower capitalization stocks.
Beginning with REG ATS in the late 90’s, the SEC has had the stated goal of transparency, and equal access to pricing by all market participants. Unfortunately, with decimalization and REG NMS, the velocity of trading has skyrocketed. While this spawned some innovative products, nevertheless it has fragmented the market place and hurt the price discovery process in an unintended way. Never did they expect there would be over 30 dark pools trading over 20% of the volume, with a great number of them being internalization engines. And never did they intend for such a large percentage of the order flow to be regulated in a different way than orders on public exchanges. Multi-tiered markets were wrong in 1998, and they are wrong today.
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