September 26, 2012

End Reg NMS

The structure of equity markets is like Lance Armstrong: Defining an industry but dogged by accusations.

The SEC seems to be in near-continuous investigative mode. Last week the Chicago branch of the nation’s central bank, the Federal Reserve, joined the cooks in the kitchen, including Congress, to huddle over the stove and study the stew.

Speaking of Congress, a bombshell detonated during market testimony last week. Bloomberg’s Nina Mehta wrote Sept 20 in an article titled “NYSE Executive Urges Assessment of 2007 Stock Trading Overhaul” that Joe Mecane, head of equities for the exchange, thinks the SEC should reconsider Regulation National Market System.

You’d expect shock. Thus far, no. But agreeing with Mecane were Nasdaq transaction services head Eric Noll and BATS chief operating officer Chris Isaacson. Rather than piecemeal reactionary remedies to yeasty glitches in trading markets, all three said, regulators should examine the extreme makeover given markets by Regulation National Market System.

SIDEBAR: Join us Friday 9/28 at 3p ET for a web meeting on using Rational Price to sort signal from noise – and to talk about Reg NMS and what issuers should do.

Amid a vast array of market minutia managed by provisions in its 500 pages, Regulation National Market System decreed that trades must meet at the “national best bid or offer.” To facilitate compliance, quotes under Reg NMS are only acknowledged if computerized. Thus, automated quotes have proliferated in continuous footraces to set stock prices.

Under the SEC plans that allocate revenues from trading data, exchanges must quote 50% of the time within the best national bid or offer and match 25% of trades there to earn top dollar from ticker-tape data. To do that, exchanges began paying traders incentives for their orders (the “maker/taker” model regulated by the SEC).

Seeking more ways to set the best bid or offer and to drive data and transactional revenues, exchanges created more venues. Simultaneously, dark pools mushroomed to escape market noise, so that now the market is a hundred fragments. Order types – technical specifications for how trades should match to comply with SEC and exchange rules – exploded in complexity to maximize outcomes and navigate the maze. No wonder nearly nine of ten trades is navigational, not fundamental.

This mess has a root cause. We’ve long advocated decommissioning Regulation National Market System. Now, exchanges are making the same argument. Your stock price is only as good as the next high-speed bid or offer. To borrow a heady phrase, that ain’t right.

If you think Reg NMS has converted equity markets from a capital-raising forum into a particle accelerator, voice your concern here before the October 2 SEC technology summit.

NOTE: If you missed our short web meeting last week on separating signal from noise with Rational Price, we’ll reprise in real time for a half-hour Friday at 3p ET. First come, first served. Click to join (just copy to your Friday calendar).

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