This piece was originally published in the Financial Times.
These are not easy times for nervous equity investors. The May 2010 Flash Crash, the Facebook IPO, and Knight Capital’s trading debacle this last summer have offered little comfort that U.S. equity markets are a safe place to trade or invest.
While 2013 has brought early stirrings of renewed interest in U.S. equities, over the past four years investors have voted with their feet, pulling more than half a trillion dollars from actively managed U.S. equity mutual funds, according to the Investment Company Institute. Despite this, U.S. equity markets remain among the most robust and transparent, leading the world in capital formation in 2012 even in the face of a weak global economy.
It is clear that investors need to be reassured, but not at the cost of disturbing the progress that has been made over the past decade in terms of lower trading costs and more available liquidity. We believe six key initiatives, some of them already much discussed in market structure circles, would go a long way toward restoring investor confidence:
- Consolidated Audit Trail: If implemented properly and cost effectively, a CAT would provide the SEC and the CFTC with an invaluable tool to police bad actors and root out predatory strategies.
- Uniform Market Wide Circuit Breakers and the Limit-Up Limit-Down Plan: Harmonizing these important safeguards across all market centers would likely prevent a market disruption of “Flash Crash” proportions.
- Excessive Message Traffic Fees: The explosion of message traffic, caused in part by the growth of high frequency trading, has burdened brokers and investors alike, acting as a de facto tax on the marketplace. These costs should be borne by high frequency traders who create excessive quote traffic without executing order flow. This could take the form of a market-wide message data fee for traders who have an extremely low ratio of order submissions to executions, similar to the excessive message fee programs that were proposed by NASDAQ and Direct Edge last year.
- Level Playing Field for Market Data: Market data should be distributed to all market participants equally; special data feeds should not form the basis of high frequency trading strategies. Where speed is concerned, it is clear that the law of diminishing returns must be applied to further dramatic shifts in the foundations of our equity marketplace. Microseconds versus milliseconds do not matter to mutual funds or retail investors, and nor should they.
- Kill Switches: Market-wide risk should be monitored at a central clearing house that would have “kill switches”, i.e. the ability to terminate a broker-dealer’s connectivity to the national market system in the event of a rogue program released to the market.
- Facebook: The SEC and FINRA must act on the NASDAQ Facebook compensation proposal. There are real investor protections that need to be upheld by regulators that are getting lost in the debate between brokers and the exchanges around limitations of liability. Analogous to the victims of Hurricane Sandy, compensation for Facebook IPO investors is being held captive by exogenous issues that should be separated from the issue at hand.
These six measures would give the investing public the protections they need to confidently invest in the world’s strongest and most resilient market while still deriving all of the cost savings and liquidity benefits which have been achieved over the past decade. The old saying about the perfect being the enemy of the good applies here: we urge regulators to take incremental steps toward improving market quality rather than waiting to enact a broad slate of changes at some unspecified future time. We are steadfast in our belief that U.S. equity markets are on firm footing, but it remains to be seen how long it will take for Wall Street to regain Main Street’s confidence.