After years of debate among exchanges, other market centers and the buy and sell sides, the Securities and Exchange Commission on June 9 published the final version of Regulation National Market System. For Wall Street technology executives, the work of modifying systems to accommodate the new rule -- which takes effect on June 9, 2006, starting with 250 stocks but extending to include all NMS stocks nine weeks later -- is just beginning.
The necessary changes will be expensive. The SEC estimates implementation costs of $143.8 million and ongoing expenses of $21.9 million a year. Boston-based technology consulting firm Aite Group puts the figure higher, predicting the U.S. securities industry will spend $544 million on Reg NMS over the next four years, with compliance-related systems consuming 55 percent of the total, routing and execution systems 33 percent and data management the remainder.
Implementing Reg NMS's centerpiece, the order protection rule, will be the major challenge. Currently, an equity buyer or seller -- typically for reasons of speed or certainty -- may agree to a transaction that "trades through," or ignores, a better price at another trading venue. The new rule puts price ahead of other factors in determining the quality of execution, effectively extending an existing New York Stock Exchange rule to all marketplaces and requiring that an order be executed at the best price available at any trading venue. The rule protects limit orders against trade-throughs when those orders are immediately accessible through automated systems.
Since major changes are needed if the industry is to be compliant when routing orders to both automated and floor-based trading venues, many observers believe the SEC will extend its June 2006 compliance deadline for the trade-through rule. (The SEC extended to January 31, 2006, its July 1, 2005, deadline for other provisions, such as a prohibition against accepting and displaying quotes of NMS stocks in subpenny increments for shares priced above $1.)
"A huge amount of systems work will have to be done," explains Deborah Mittelman, senior vice president of compliance and product management at Sun-
Gard's Brass, a provider of software used to manage orders and access markets. She foresees changes in trading algorithms, market data feeds and routing systems so that manual quotes -- which are not protected from trade-throughs by the new rule -- and protected automated quotes can be separated.
Also requiring considerable programming and operational changes for implementation, she says, will be intermarket sweep orders, or ISOs -- orders that one trading center sends to another when attempting to satisfy protected quotes. The ISO designation will instruct the receiving market not to apply the order protection rule, because it would spark a fission of redundant orders across markets. To make ISOs work, communications protocols, such as FIX and CMS, will need new intermarket order codes; firms sending ISO orders will have to use new tags.
Tying the new rules to the NYSE's existing floor-based and upcoming electronic models "will involve more than 100 software releases," says an exchange spokesman. Fewer tweaks will be needed on Nasdaq, where the "most daunting" project will be assembling a firm-user database and examining it to ensure that trade-throughs are handled with the proper exemptions, says Christopher Concannon, Nasdaq's executive vice president of transaction services. Before launching these projects, he and others are waiting for the SEC to offer its views on the industry's attempts at compliance, which the Securities Industry Association and other industry groups are currently addressing.
For the new front-end displays, order types, messages and audit trail requirements that he sees coming, "it's too soon to start coding," says Matthew Lavicka, managing director of equity trading at Goldman, Sachs & Co. and chairman of SIA's NMS implementation committee. "We can start working on 10 percent of what needs to get done," he says. "Ninety percent of the job is not clear."