September 10, 2014

Big Opportunity

Amazed. Dazed. Perhaps needing a drink.

Thus shown the faces of investor-relations practitioners at yesterday’s NIRI Southwest Regional Conference as Rajeev Ranjan from the Chicago Federal Reserve Bank put up his final slide and pronounced it a graphical representation of market microstructure. It appeared to be some sort of complex engineering schematic.

And it reflects how stocks trade today. Many say, “Ignore high-frequency trading because it’s noise from those who don’t care about fundamentals.” If traders oblivious to fundamentals and uninterested in owning your shares routinely price them and all other equities, how can you rely on prices the market displays that underpin the corporate balance sheet?

Proving that even the SEC is antsy now about this structure, a tick-size study to consider wider trading spreads is nearing finalization. Did you get the memo? No?  Exactly. Public companies have been omitted – but the comment period is coming! If ever public companies needed to speak up, this is the opportunity. With that preamble, we’ve reserved today’s Market Structure Map for yesterday’s blog post from our good friends at Themis Trading. Take it away, Joe and Sal:


While we in the trading community continue to debate the merits of HFT and the structural defects in our market structure, there continues to be a group of market constituents that remains silent in the debate – the public companies.  The stock market has undergone dramatic structural changes over the past decade but many of these changes were done without the input of the public company.

Public companies are the reason that the stock market exists, they are what research analysts cover and who bankers seek to do deals with. Without listed public companies, there would be no S&P 500 ETF or E-mini futures contract.  There would be no rebate or latency arbitrage that hinges on microwave networks and football-field-sized data centers.

We’re not quite sure why the public company largely remains silent in the market structure debate.  Possibly, it is because market structure has continued to get more complicated and they fear they are not up to date on the changes.  Or possibly, they feel that in return for annual listing fees, the stock exchanges should be representing their views.  Considering that exchanges now get most of their revenues from data-related services, looking out for public companies seems to be on the back of their to-do list.

While our friend Tim Quast from ModernIR continues to speak out on structural issues on behalf of his public-company clients, it is rare that we see any others in that segment speak out.   However, we recently came across an article written in Canada’s Financial Post by David Beatty, which tackles the issue of market structure and public listings. Mr. Beatty is Chairman of the Board of Canada-based Rubicon Minerals and is also on the Board of Directors for First Service Corporation and Canada Steamship Lines.

In this blistering piece, Mr. Beatty calls out the exchanges and their high-frequency trading friends for their neglect of the true purpose of the equity market – capital allocation.  He also attacks the short-termism of the HFT renters of the market:

“We have heard the woes of dealers and investors impacted by predatory HFT. But do we understand the impact HFT is having on our publicly listed companies? For a number of dominant HFT market participants, these companies have simply become a commodity, traded not for their fundamentals, but for how they fit in an algorithm executed almost at the speed of light.

“Since the onset of high-frequency trading and the erosion of true market makers, liquidity in public companies has been concentrating in an ever smaller group of large-cap stocks. As a consequence of increasing costs, caused by HFT-driven market dynamics, dealers have been downsizing their sales support and research capability for small and mid-sized corporations.

“How does this facilitate building new and strong companies? As existing exchanges and alternative marketplaces greedily focus on catering to the needs of high-frequency traders, because volume equals money, they are doing just the opposite for issuers. Instead of meeting the issuers’ needs, they have stripped them from the benefits of being publicly listed – true liquidity – and left them with no longer justifiable regulatory, financial and management burdens. It is no surprise that companies are shying away from public listings and seeking private or international alternatives. This does nothing to accelerate the growth of the Canadian economy.”

HFT supporters would like to keep distracting policy makers and regulators with their “we shrink spreads and add liquidity” arguments but the real issue is what has happened to the ecosystem of our stock market.

As Mr. Beatty rightly points out, support for small and mid-sized companies continues to diminish due to the lack of economics in this business.  Regulators in the US seem to have finally realized this and are about to implement a tick-size pilot program, but more still needs to be done to stop the hollowing out of our equity market.

Mr. Beatty’s piece is a good start but we wish that some other public-company directors in the US would follow his lead. This forgotten group needs to speak up and let their voices be heard.

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