The SEC Needs a Market Structure Reset
Securities and Exchange Commission Chair Clayton thoughtfully entered the market structure debate in a speech earlier this year saying the “focus on market structure issues will, as always, start and end with ensuring that our markets meet the needs and serve the interests of our long-term Main Street investors.” We believe the Chair was signaling his concern that small business owners looking to take their company public and retail investors who seek market stability may not be adequately served by today’s market structure.
Market structure is a function of regulation, technology, and competition. Government sets the rules in a zero-sum game and market participants compete to obtain the best technology, so they can extract profits before everyone else catches up. Today, we have a hyper competitive market because everyone whose business model depends on it has access to similar technology and the rules haven’t changed. As a result, both costs and margins have come down significantly and the market has reached a point of maximum efficiency, while innovation has become increasingly difficult.
At this stage, market participants are left with two options: lobby the regulator to change the rules in a way that will increase their profits at the expense of others or ask for a total reset of how the game is played. We support the later.
After eight years of around the margin discussions on the topic, the current Commission clearly sees the self-interested lobbying in this area for what it is: companies trying to use the government to inflate their profits at the expense of individuals and families seeking to grow their wealth in the stock market. The Commissioners have all issued calls to change course, and we hope they will do that by looking at the bigger picture.
To do this, one question is instructive: in a capitalist society with a highly competitive market structure, why should the government intervene to tweak rules around the edges that benefit one market participant over another when they have no impact on capital formation or market stability? It shouldn’t.
Market structure must support small business capital formation and market stability. Currently, it does not. The big picture discussion must recognize that different tiers of market structure exist; that the current one-size-fits-all regime has contributed to a decrease in IPOs; that the reliance on “time-price” priority exacerbates price moves in all securities; and that when retail investors and small business owners see the market nose dive over 1000 points in thirty minutes of trading, it does not instill confidence in the market.
The Commission must get back to basics when addressing market structure. Basics dictate that the system support the dream of small business owners who want to take their company public and enhance investor confidence by limiting market instability. This is the only way the Commission can promote job creation and ease the concerns of retail investors and small business owners who worry that their life savings could evaporate due to an algorithm gone wild.
The Commission can hand Main Street a win by changing the core of today’s one-size-fits-all market system rules to recognize that (1) different tiers of market structure exist within the current system; (2) the order handling, time-price priority, and best execution obligations must make sense for each tier or they should be eliminated; and (3) in evaluating the societal benefits of the reliance on speed and complexity in the lower tiers of the market, Wall Street dark pools and high frequency traders must take a back seat to Main Street.
Wholesale changes to the core of the national market system seem to be the only conclusion that will help more small businesses IPO and protect investors. Unfortunately, it’s this conclusion that many in the industry may lobby against.