News & Views

Adam’s Take: SEC 2018: Life After the Close


The Big Picture
In the first several months of Jay Clayton’s tenure as SEC Chairperson, his focus on equity market structure has been aimed at capital formation and the listings business. We might have seen this coming when several of his initial hires came from a corporate finance background (as opposed to the typical lawyers who usually fill the halls at 100 F Street NE). Once he had some staff support, he dug in, pushing forward with rulemaking aimed at helping ease disclosure burdens. One directive was specifically aimed at pre-IPO companies, while the other was the approval of a NYSE rule change to allow for direct listings. This, as we now know, is giving birth to the Spotify IPO that really isn’t an IPO. Regardless, both are examples of how the SEC has prioritized reducing the frictional costs of going public.

However, equity market structure change is also on the front burner. Clayton has talked about his guiding principles on market structure. In his first speech as SEC Chairperson1, the Chairman reiterated the long-held SEC view that its mission is to protect the “Main Street” investor. What stood out though was his use of the “Mr. and Mrs. 401(k).” Maybe I am reading too much into this, but this phrase could be a recognition that only 37 percent of household equity investment is done directly.2 Therefore, one could reasonably argue (as we often have) that the best way to protect retail investors is to protect the institutional orders that represent them. Maybe that’s why in October, Brett Redfearn, longtime JPMorgan market structure analyst, was named Director of Trading and Markets. Clearly, Mr. Redfearn is well versed on the issues facing institutional orders. This should bode well for some positive changes in equity trading rulemaking.

Save the Bell, No More
The approval of CBOE’S proposal to execute “Market on Close” orders is another clue as to the SEC’s view on market structure, but whether CBOE will be successful in lowering the cost of the close is hard to say. While CBOE BYX is an Exchange, the approval is further proof that the SEC is likely to favor proposals and rules that continue to chip away at the incumbent Exchanges’ stranglehold over certain areas. Clearly, the close is one of those areas.

The CBOE proposal successfully pushed back the argument that fragmentation of the close could diminish its price discovery. CBOE limited the functionality to MOC, so it merely piggybacks off the primary’s auction. While the incumbents argued that any competing close process could cause harm, the SEC didn’t buy that story. As the SEC states in its approval:
“The Commission believes that matching paired-off MOC orders in the manner BZX proposes would not affect the net imbalance of closing eligible trading interest in the market. As such, the orders that actively participate in, and contribute to, the price formation process in a closing auction – including limit orders and unpaired MOC orders – would not be executed in the CBOE Market Close and could continue to be submitted to the primary listing exchange.”

The last part of the statement may point to one reason the CBOE Market Close may succeed. The cut off time is 3:35pm, after which the orders are matched or cancelled. This reduces the opportunity cost of trying the CBOE Market Close because traders still have time to route to the primary. In addition, CBOE will publish the amount that has been matched, giving market participants more information about the potential close liquidity in that name.

CBOE says it might be about a year before they are ready to launch, but NYSE has already announced a drop in price. So even if CBOE doesn’t attract a lot of MOC biz, they can always claim a moral victory.

We Don’t Need No Stinking Ideas
In reading the tea leaves of the SEC, I think the current regime’s attitude will be, in the words of Elvis, “a little less conversation, a little more action.” In fact, I think one reason the SEC terminated the Equity Market Structure Advisory Committee (EMSAC) is because they don’t need more ideas. It’s time to start taking action.

In December, an SEC official speaking at an industry conference laid out an ambitious schedule of market structure rulemaking for 2018. Overall, this is what we can look forward to in the coming months:

  • A proposal for a market access fee cap that will include the controversial zero rebate bucket. This proposal would go one step beyond the EMSAC recommendation and ban any rebate for stocks in that bucket.
  • Approval of Regulation ATS-N with minor changes from the existing rule proposal. Reg ATS-N will dramatically increase the amount of public information on ATS operations. I shared my thoughts about Reg ATS-N when it was first proposed. You can read it here.
  • Approval of the Institutional Order Handling Disclosure Rule proposal. Not only will this rule increase public information on how brokers handle institutional orders, but it also forces brokers to make in-depth data available to clients on request. For more information on this rule, click here.
  • Finally, there is a lot of anticipation that the SEC will take up the issue of Exchange market data fees. Market participants have been complaining about the rise of market data charges for a long time with nothing to show for it. But with SEC leadership stacked with lots of ex-Wall-Streeters, everyone but the incumbent Exchanges are hopeful that their voices will finally be heard.

I would have thought that such an ambitious schedule would contradict an important guiding principle of conservative regulatory policy: cost benefit analysis. For example, I believe we would be hard-pressed to justify the costs of the Tick Pilot based on the results across all three groups. The support of another pilot signals the SEC’s belief that testing the impact of various rule changes is worth the cost. The value is in the data, not the outcome.

While conceptually I agree with this philosophy, I am more sympathetic to calls for simplicity. If we want to truly test alternatives to today’s market structure, let’s have a Reg NMS Recall Pilot.

That would answer just about every question.


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