US stock markets put investors first

Public exchanges today offer trading and data services that are more valuable, efficient and resilient than at any time in history and at the lowest cost to investors. Recent suggestions otherwise by exchange critics are unfortunate and overlook several important realities about how our capital markets work today. 

For starters, all capital markets participants are “for profit” — investors, market makers, banks, brokers, venue operators, issuers, traders and everyone else. There is no such thing as a not-for-profit capital markets participant.

{mosads}When today’s for-profit national securities exchanges were still member-owned, it was the broker members who retained the profits exchanges earned, enabling the exchanges to remain technically “not-for-profit.”

But then and today, public exchanges remain the most heavily regulated and transparent participants in our capital markets. They are required to compete with over 50 alternative trading systems, more commonly known as dark pools, which are all run by financial institutions and on which 40 percent of equities trading occurs.

In contrast to public exchanges, dark pools are subject to lighter regulation and can discriminate among customers by negotiating undisclosed fee arrangements with each of them.

This complex, fragmented market structure is a result of the Regulation National Market System (Reg NMS), not exchanges’ ownership structure. Reg NMS precipitated the need for market participants to demand greater access to information and connectivity at faster and faster speeds. 

The Securities and Exchange Commission (SEC) introduced Reg NMS with the stated goal of creating greater competition for exchanges and other trading venues at the behest of investors seeking lower costs to trade. It also promoted the use of automated trading systems at the expense of manual open outcry trading floors.

This has forced exchanges to evolve and modernize. But this also required significant systemic and technological changes. Becoming listed entities in their own right enabled exchanges to access the capital markets — like any other for-profit entity — to make the technology investments to compete and deliver the services their clients demand.

Reg NMS was successful in its goal. We now have more than 13 equities exchanges competing aggressively for both listings and trading market-share. This competition is what constrains prices for the well-funded trading firms that buy proprietary data.

The exchanges compete not only for consumers of analytical, data and index products, but for the order flow that is the very lifeblood of their existence. 

Adding to this landscape, they also compete against their own clients — large investment banks and broker dealers, who through these Reg NMS changes are even better able to act as quasi exchanges by matching the buy and sell orders received from their clients without sending them to an exchange.

In this more-fragmented market, data and access are critically important. Price discovery and trade execution are more efficient today because of public exchanges’ investments in technology, not in spite of them.

Lit quotes — posted by liquidity providers on public exchanges — are the raw material that allow every market participant to trade with confidence. They even power the dark pools, which rely on displayed quotes from the public exchanges to match buyers and sellers on their internal trading platforms.

The reality is transaction costs for investors are the lowest they’ve ever been. They also enjoy instant access to robust real-time market data on their smartphones, for free.

This is no accident; it’s the result of significant investment by exchanges to ensure ”The Tape” is of the highest quality and speed, all while the cost to investors has declined. 

Given that the majority of retail trades are executed in the dark pools, shouldn’t the SEC focus its attention there rather than on a corner of the market that is already the most transparent and heavily regulated?

The path recently proposed will push more and more trading onto the dark pools, and that will lead to a significant erosion of market quality as the percentage of the market represented by lit quotes declines.

The answer to strengthening the quality of our free market is in free-market principles, not government price-fixing. If exchanges are turned into public utilities, then competition decreases, and investors will ultimately lose.  

Furthermore, there is no evidence that government price-fixing will have any impact on individual investors, particularly when it does not appear that the prices will be fixed everywhere a trade can happen, data can be sold or technology services can be provided.

Selective overregulation of exchanges, through pilots or otherwise, without consideration of the other 40 percent of the market where transactions occur is more likely to simply be an additional boost to the record profits of big Wall Street firms and unregulated third-party data providers who are looking for government intervention to minimize their costs. Exchanges believe customers are best suited to control costs in a competitive environment. 

Today, the fees that exchanges charge for data services are reasonable. In fact, our collective revenues are one one-tenth of the $12 billion in revenues collected by thid-party data providers who take exchange data and resell it to market participants at significant markups. 

According to the dark pools, we should put our faith in them. We can’t see what’s happening there, so we’ll just have to trust them.

Free markets operate best when providers compete in a transparent environment. The well-funded institutions would benefit from government price controls, but in the end, the individual investor pays the price for stifled competition.

Former Rep. Mike Ferguson (R-N.J.) is the executive director of the Equity Markets Association, a cooperative whose membership includes the Nasdaq and the New York Stock Exchange. He is a senior advisor of Baker Hostetler.