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Regulation and Innovation Collide in the Best Possible Way

Compliance with new standards might very well end up optimizing best ex for everyone

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Regulatory change is sometimes viewed merely as a hassle to be complied with, but more often than not it also sparks innovation. The SEC’s and other regulatory bodies’ determined focus on transparency around execution quality and the costs associated with it is a prime example. In short, the transparency push is about all market participants having access to the information they need to make optimal decisions to achieve their trading objectives. By leveraging technology to comply with transparency mandates, equity traders may also find massive efficiency and performance benefits.

Top of mind for traders as 2019 unfolds are issues around market data pricing, SEC Rules 605 and 606 (which standardize public disclosure of execution and routing practices), the Transaction Fee Pilot, and how the new Members Exchange (MEMX) founded by nine members comprised of large banks and financial services firms, retail broker-dealers, and market makers, might change the equities trading landscape. These issues are all tied together in various ways, but the ultimate goal is to make markets as efficient as possible so that capital formation can more easily occur and end investors can benefit from this growth.

“The big theme across the board from a regulatory standpoint is a real shift of responsibility in terms of how to get best execution,” says Joe Wald, CEO and Founder of Clearpool, a provider of holistic electronic trading solutions. “It is no longer just a check of the box that the sell side has to provide. It is now a collaborative discussion between the buy and the sell side. They need to work together to build out execution protocols designed to meet unique trading objectives. Now is the time for market participants to get smart about what tools they have available to them, and to understand how microstructure decisions can really impact execution quality.”

Innovative technology pushes move beyond conflicts of interest

If not quite a tale as old as time, this challenge isn’t especially new. Over time, conflicts of interest are created when people look to take advantage of existing standards. The latest wave of standards insists that the rationale behind transactions be visible to everyone involved to remove any hint of sleight of hand.

“MEMX is a direct response to the lack of transparency from other exchanges with respect to how they price market data,” says Wald. “We’ve gotten very, very far away from the fair and equitable pricing that exchanges are supposed to provide for members. What exchanges have basically done is create a system where the small are subsidizing the big. That is as far away as you can get from a fair and equitable allocation of costs. They’ve taken what seems to be a privilege and turned it into a way to keep people hostage with respect to pricing. That is ultimately unsustainable if we want the most efficient capital markets in the world. If you have excessive waste on market data, it’s coming from somewhere, and that somewhere is the end investors.”

Technology may not extinguish the impulse that some people have to skirt the rules, but the tools available make the idea of doing so pointless. “The most important thing market participants can do today is get to know and understand the many new tools that are available to them,” says Wald. “They can work together with technology providers, and they can work together with their buy side clients to figure out what they need to do to achieve optimal execution quality, and how together they can leverage the right tools to achieve that goal.”

This element of human collaboration around choosing and working with the best tools for the job is a step in the ongoing evolution of equities trading that began with the order management system (OMS) and the execution management system (EMS). The latest phase of that evolution is occurring at the microstructure level with algorithmic managements systems (AMS).

“The AMS is a critical component of being able to tie all these things in together and achieve an optimal trading model,” says Wald. “TCA [transaction cost analysis] provided us with a way to view performance metrics at a high level in the context of certain compliance and rules. The OMS streamlined the ability to send orders, and the EMS took it a step further by giving the trader more control. The AMS is that next evolutionary stride – a deep dive into venues, order types, and how to put them altogether to create a scenario where you’re working collaboratively and transparently to achieve the outcome you want from the execution.”