Those were some of the issues aired in a U.S. Senate Banking Committee hearing Tuesday, at which senators grilled officials from NYSE Euronext, Nasdaq OMX Group Inc., Credit Suisse Group and independent research broker Investment Technology Group Inc. about computerized trading venues and what the so-called rules of the road should be.
Executives from the two exchanges and the two Wall Street firms were able to agree on at least one point: the introduction of kill switches might help curtail technology-induced market meltdowns. A kill switch would ostensibly cut off software-related trading glitches before they could go viral in the market, a problem that has occurred a number of times in the past year. In August, the venerable securities firm Knight Capital Group Inc. almost went belly-up because of electronic-trading glitches that cost the firm $440 million. (Update: On Dec. 19, Knight Capital announced it would merge with Getco Holdings Co. LLC.)
On that issue, at least, progress may be around the corner. Joe Mecane, executive president and head of U.S. equities at the NYSE, said during his testimony that exchanges and regulators are getting closer to hammering out a plan on how kill switches might work and that a proposal may be ready in the first quarter of 2013.
"All the SROs [self-regulatory organizations] and firms on this panel have been involved in discussions around kill switches," he said. "We're all engaged in assessing how [it] might work. It's very complex, but we believe we're getting close to a framework."
Beyond this, however, agreement on how the U.S. equity market structure should be revamped, if at all, will likely be a longer, tougher slog. Over the past several months, regulators and politicians have been squaring off with stock exchanges and Wall Street brokers over a range of contentious issues, including ways speed-addicted high-frequency traders may induce market makers and exchanges to bend the rules for them.
In September, for example, the NYSE paid a $5 million fine to settle Securities and Exchange Commission allegations that it had provided select customers with a speed advantage by giving them early access to market data. This issue of market fairness remains a highly sensitive point, one which Nasdaq's Eric Noll, head of the exchange's transaction services, weighed in on at the hearing, saying that Nasdaq doesn't "provide advantages to certain users to let them jump ahead. We go through a rigorous [process]. ... We are passionate about the critical role we play in capital formation."
Tuesday's hearing, the second in a series the Senate committee is holding to explore issues about market structure, was an effort to get a better handle on ways to deal with the market's growing complexity. Today, for example, there are 13 registered U.S. exchanges active in the equities markets and 40 alternative venues, each with their own order types.
All this competition has helped fuel an escalating need to trade at lightning speed, which has caused an increasingly heavier dependence on new technologies and software that aren't always thoroughly tested or which otherwise can fail. The race to corner liquidity has become a brinkmanship game of trading in milliseconds and being the provider of the best and most current market data.
Ultimately, some of the high-stakes issues with potential to affect the bottom lines of exchanges and Wall Street players include whether there should be tighter regulation of off-exchanges such as dark pools, as well as the size and speed of trades.
"Our main message is that if we want to reduce the complexity of technology and our markets, we should simplify the overall market structure," Mecane said.
But that begs the issue of how to achieve greater simplicity. Even the exchanges agree that high-frequency trading is an essential part of liquidity (and one of the reasons for today's greater complexity). Paradoxically, the needs of those traders have led to greater market fragmentation. Tabb Group LLC says one-third of the market now trades in off-exchanges. In a recent survey, the research firm found that while the buy side embraces alternative venues such as dark pools, "60% acknowledged that the level of off-exchange trading impacts market quality."
This issue of market quality, including price discovery, has been a dividing point between exchanges and those who trade in or promote off-exchange trading platforms. While Robert Gasser, CEO and president of ITG, said an increase in off-exchange trading doesn't hurt price discovery. Noll said this wasn't so. "I disagree that an increase in off-exchange trading is not harming price discovery -- there have been instances of that."
For his part, Dan Mathisson, head of U.S. equity trading for Credit Suisse, disputed that there had even been an increase in off-exchange trading the past five years. "If you go back to 2007, 30% was traded off-exchange." He said this level has fluctuated between 25% and 30% every month for the past five years.
"You have to be creative to come up with a trend that [shows more trading] is moving off exchanges," he countered.
Mathisson added that it was important not to lose the benefits of competition and that he's against imposing speed limits for trading.
As the market has already seen for some time now, this issue of speed and how and if to regulate it may prove to take the longest to resolve.
Because, like it or not, high-frequency traders have become a key fixture in the fabric of the U.S. stock market liquidity picture.
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