SEC Chair Highlights Intersection of Finance and Technology in Equity Markets
Commentary by Steven Lofchie
At the Global Exchange and FinTech Conference, SEC Chair Gary Gensler described how developments, such as payment for order flow, gamification and best execution in the national best bid and offer ("NBBO"), have increased market segmentation and market concentration in the equity markets.
In his remarks, Mr. Gensler contrasted the "lit" exchange markets (e.g., Nasdaq and NYSE) with off-exchange wholesalers, stating that wholesalers gain an advantage when it comes to pricing because they can price their segmented order flow by referencing the less competitive NBBO, whereas exchange market-makers must compete with each other on an order-by-order basis. Mr. Gensler also noted that payment for order flow and the growing impact of data have led to a market concentration within the off-exchange market-maker space, in which data from the transaction flow increasingly goes to a small group of wholesalers, who then gain an advantage from access to this data.
With regard to gamification, Mr. Gensler stated that, while such behavioral prompts in brokerage apps generate more active trading, this same "active trading" is correlated with lower returns for the "average investor."
Mr. Gensler cautioned that a broker-dealer's best execution obligation may not be met by execution at the NBBO, which is not a "complete enough" representation of the market, as it does not reflect (i) dark pools and wholesalers, or (ii) a significant portion of trading that happens away from the lit markets as a result of market segmentation.
Mr. Gensler also expressed his support for shortening the standard settlement cycle, not only to T+1, but to same-day settlement: T+0 or "T+evening."
Commentary
Chair Gensler raises important questions on market structure. Markets and market technology have changed since the adoption of Regulation NMS. Improvements require periodic and substantial revisits.
That said, pushing for T+0 settlement seems to be evidence of an overwillingness to force changes that may be detrimental in practice. The rate and amount of change simply may be more than businesses can bear. The impetus to move to T+1 settlement was arguably an overreaction to issues caused by the GameStop run-up; achieving T+1 settlement will require substantial operational changes and costs. Is there really a material benefit to advocating for same-day settlement? Substantial regulatory and technology changes on this scale contribute to driving firms out of business because they do not have the size to support the associated costs.