Regulators should make the approval process for new stock-market order types more stringent to simplify trading and boost investor confidence, said David Lauer, a consultant at Better Markets Inc.
Approval for order types should be denied when there is no “clearly demonstrated utility” to long-term investors and market stability, he said today at a U.S. Senate Banking Committee hearing. Exchanges offer multiple order types so traders can tailor transactions based on price moves or other conditions. Some give users control over when and how they execute a trade request while others allow firms to keep their place in line for orders or avoid routing to other venues.
“The bar for approving new order types needs to be revisited,” said Lauer of Better Markets, a nonprofit group that promotes financial reform. “It would re-instill confidence in the marketplace if it was easier for the average person to get their head around what these order types mean.”
The adoption of a set of rules known as Regulation NMS has led to a fragmented market in which orders are executed on 13 exchanges, several alternative venues, more than 40 dark pools and through other broker-dealer systems. The rules also drove a focus on speed and led to the expansion of order types for high-frequency firms, Joseph Mecane, head of U.S. equities at NYSE Euronext, said yesterday at a conference in Washington.
While there are too many order types, the review procedure is not failing, said Chris Concannon, a partner and executive vice president at New York-based broker Virtu Financial LLC. He is also a former Securities and Exchange Commission official and Nasdaq OMX Group Inc. executive.
“I personally filed order types,” he said at today’s hearing. “It is a difficult process to get these things approved.”
By spawning faster trading, Regulation NMS cleared a path for for-profit exchanges and brokers to cater to high-frequency firms, which provide more than half of the volume in the market, Mecane said. Exchanges offer several order types, or automated instructions that determine the series of actions a buy or sell request can take, to high-frequency and other users with “economically sensitive” trading strategies, he said.
The SEC in February sought information about how order types have evolved at Bats Global Markets Inc., the third-largest owner of U.S. equity exchanges by volume. Bats said regulators asked for documents “related to the development, modification and use of order types, and our communications with certain market participants,” including some of Bats’ owners.
“We need much more transparency on these order types,” Larry Tabb, chief executive officer of research firm Tabb Group LLC, said at today’s hearing. “Should the SEC be looking over these in more detail? I think yes.”