A majority of the five-member U.S. Securities and Exchange Commission wants the agency to review whether stock exchanges should continue to have regulatory roles that include overseeing members who may run competing venues.
Advocates of such a review say the special status creates benefits and burdens for exchanges such as IntercontinentalExchange Group Inc.’s New York Stock Exchange: They must compete with venues that don’t have to follow as many rules while also having a level of authority over brokers that operate the competing trading systems.
SEC Chairman Mary Jo White and Commissioner Daniel M. Gallagher have said the exchanges’ regulatory roles may be at odds with their need to compete with trading venues including dark pools, which, unlike traditional exchanges, don’t list bid and offer prices for the rest of the market to see. Commissioner Kara M. Stein was the latest to question the exchanges’ roles, saying their status merits “significant reconsideration” in a Feb. 6 speech to a New York conference.
“We now have our current competitive market structure, but the one thing Congress did not think through was how to regulate a competitive market structure,” said James J. Angel, a professor of finance at Georgetown University and former board member on exchanges operated by Direct Edge Holdings LLC, which was purchased this month by Bats Global Markets Inc. “It’s about time.”
Exchanges’ self-regulatory functions are enshrined in the federal securities laws and predate the creation of the SEC in 1934. The exchanges held onto benefits from their special status such as the sale of lucrative market data and limits on private lawsuits against them, even as they became for-profit entities. At the same time, exchanges must publish and seek approval for their rules, such as special order types.
“The fact that brokers are not subject to the fair access rules like the exchanges and can offer a unique experience down to the fees and order types is what really makes them difficult to compete with for the exchanges,” said Justin Schack, managing director and head of market structure analysis at Rosenblatt Securities Inc.
White told the Security Traders Association in October that the SEC should examine whether current rules permit exchanges the “flexibility” to “effectively compete” with other venues. The chairman also questioned whether rules for the exchanges’ competitors should be recalibrated.
“The current nature of exchange competition and the self-regulatory model should be fully evaluated in light of the evolving market structure and trading practices,” White told the conference.
The Securities Industry and Financial Markets Association, which represents brokers, says the self-regulatory model also creates conflicts of interest for exchanges by asking them to regulate members that operate competing trading venues.
Exchanges execute about 62 percent of total share volume, according to data compiled by Bloomberg. The rest is handled by alternative trading venues including dark pools such as Credit Suisse Group AG’s Crossfinder and Morgan Stanley’s MS Pool, as well as internal platforms at broker-dealers that, unlike exchanges, don’t have to publish their rules or treat all orders the same.
“How should we rationalize the discrepancies in regulatory treatment between a dark pool and an exchange, given that they are expected to perform the same generalized function: serving as a place to match buyers and sellers?” Stein said in her speech to the TraderForum 2014 Equity Trading Summit.
NYSE spokesman Eric Ryan and Nasdaq spokesman Rob Madden declined to comment.
SIFMA last year urged the government to strip exchanges of their status as self-regulatory organizations, which puts them in the position of overseeing some of the same firms that also run alternative trading platforms.
“Conflicts of interest in this model abound and only worsen as they are left unresolved,” Theodore R. Lazo, associate general counsel at Sifma, wrote in a letter last year to the SEC.