Since May 6, 2010, the U.S. equity trading industry has been
going through the five stages of grief. We are currently in the
fourth stage, depression. It is not clear to me if the industry
will ever move on to the next and final stage of acceptance and
recognize that U.S. equity market structure is mostly okay and
only requires a few tweaks around the edges.
I do not believe that the so-called flash crash, and the
increased awareness of various market structure foibles, has
had a long-term impact on asset allocation decisions. Country
equity fund flows continue to be highly correlated with
emerging markets continuing to win market share. But the
reexamination of market structure in the wake of the flash
crash helped identify room for improvement in three areas.
First, the single-stock circuit breakers should be replaced
with a rule (limit up/limit down) that would not even let
wildly mispriced orders into the market. Second, there should
be greater harmonization of rules across the equities and the
derivatives markets, especially since there will be an
increased number of points of failure when over-the-counter
(OTC) derivatives shift to exchange-like trading platforms
called swaps execution facilities (SEFs) and trade more
Third, there should be increased flexibility in the way
stocks can trade under the Regulation National Market System
(NMS). Currently, stocks across any market capitalization all
trade the same way.
There is broad agreement that replacing the single-stock
circuit breaker with a limit up/limit down rule has not
advanced much. Meanwhile, we are seeing stocks unnecessarily
trigger the circuit breaker for price movements that are
natural and with good reason. Within a given timeframe, 133
circuit breakers were triggered by news events (is this really
necessary?) while only 25 circuit breakers were triggered by
bad prints or fat fingers.
Regulatory harmonization is a little bit trickier. The
institutional differences between the Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission
(CFTC) and the different needs of their respective markets mean
they will not see eye to eye on everything. Furthermore,
industry participants currently regulated by one commission
would not want to switch to another. But this need to have a
common regulator for a particular asset class was recognized
under Dodd-Frank, and the SEC will regulate equity swaps. So
its a start.
In terms of flexibility, it makes sense to have a single set
of rules for all equity and equity-like products. Investors
should not have to think about how the rules of the game change
depending on the security they trade. The matching of buyers
and sellers does not need to be a Rube Goldberg. And yet, when
a single rule set is coupled with the notion that there should
competition among the execution venues, we get a market
structure that is overly complex and too constrained.
There should be more flexibility around how different types
of stocks and exchange-traded products trade. A few modest
proposals that have been floated in the past include a variable
minimum tick size, changing how block orders can be traded and
printed, and other forms of limited exemptions. I am not
advocating any particular change. The SEC should solicit
comments for ideas on what kind of pilot program would help us
understand what rules would best fit securities with different
I am not predicting that any of this will happen. There is
no question that the SEC has a significant number of important
issues to decide in the coming months. The U.S. equity market
structure is still one of the best in the world. But the flash
crash shined a light on a few areas that could be improved.
Adam Sussman is the director of research at the TABB
Group, based in New York City.