Rules governing U.S. equities trading should be pared back because regulations have made the market vulnerable to breakdowns, according to a senior executive at the company poised to buy the New York Stock Exchange.
Tom Farley, the senior vice president of financial markets at IntercontinentalExchange Inc., said that regulations introduced since the late 1990s have forced “unnatural competition and evolution” between public exchanges and among equity venues run by broker-dealers. Atlanta-based futures market owner ICE is acquiring New York-based NYSE Euronext, which also runs Europe’s second-largest futures exchange.
To improve the U.S. stock market, “I would probably start by getting rid of rules -- and some pretty big rules,” Farley said today at a Baruch College conference in New York. He declined to identify those he would prefer to eliminate. “There’s been several significant rules that have been layered on in the last 15 years that have resulted in a costly and complex market,” he said.
Farley spoke almost seven weeks after Nasdaq OMX Group Inc., NYSE Euronext’s smaller competitor, was forced to halt trading of the U.S. companies it lists for three hours because of a software malfunction. In the aftermath, U.S. Securities and Exchange Commission Chairman Mary Jo White told exchanges to collaborate on preventing breakdowns. The disruption followed a series of breakdowns on markets around the world that Standard & Poor’s said on Sept. 19 could threaten industry credit ratings.
The Internet and lower-cost computer hardware fueled the creation in the 1990s of trading platforms such as Island ECN Inc. and Archipelago LLC, which were ultimately purchased by the biggest incumbent exchange owners, Nasdaq and NYSE, respectively. Those systems helped lower investors’ costs, a shift that was accelerated in 2001 when the SEC shrank the minimum stock price increment to 1 cent, cutting profits for market makers.
Then, in 2007, an SEC rule known as Regulation NMS went into effect, requiring stocks to trade on whatever market has the best price at any given time. That helped ingrain the fragmentation of U.S. trading, which now takes place on more than 50 systems, including 13 public exchanges as well as private venues and internal platforms at brokers.
Futures trading is less segmented because U.S. derivatives markets own their own clearinghouses, meaning investors have to exit positions at the same exchange where they entered them, such as those run by ICE or Chicago-based CME Group Inc. That has created a high barrier to entry in futures trading and limited competition.
“The futures markets aren’t perfect, but I was the president of our U.S. futures market for seven years and I never once had anybody complain” about liquidity, Farley said today. “There are whole conferences dedicated to the issue in equity markets.”
Reg NMS should be reconsidered, SEC Commissioner Daniel Gallagher said last week. “It’s a prime candidate for a retrospective review,” he told the Security Traders Association market structure conference on Oct. 3.
The commissioner, one of five members of the SEC, also said the agency should examine other rules, including the move to quoting all U.S. stocks in 1-cent increments. He spoke a day after White, the SEC chairman, said the exchanges’ business models and regulatory roles should be “fully evaluated in light of the evolving market structure and trading practices.” She hasn’t publicly endorsed a review of Reg NMS.
The fragmented nature of the U.S. stock market contributed to Nasdaq’s Aug. 22 malfunction, Farley said today.
“The equities markets are so complicated, you can’t help but have the problems we’ve been seeing recently,” he said. “At ICE, we’ve not had a major outage in years. It’s not because we’re better technologists, but because we run simpler markets.”
ICE’s motivation to buy NYSE Euronext may be driven more by a desire to own NYSE Liffe, Europe’s second-largest derivativesplatform, than expanding into stocks.
ICE Chief Executive Officer Jeffrey Sprecher, who currently specializes in energy commodities and guaranteeing credit- default swaps, tried and failed twice to gain interest-rate futures through acquisitions: in 2007 with the Chicago Board of Trade and in 2011 with Liffe. Sprecher plans to pare NYSE’s equities business by jettisoning its European stock markets through an initial public offering.
Farley said action should be taken to improve the structure of American equity markets, where companies valued at about $20 trillion trade, according to data compiled by Bloomberg.
“I’ve met with dozens of people in the industry in the past year: customers, buyside, high-frequency traders and issuers who list on Nasdaq and NYSE,” he said. “If I had to write a memorandum, and give it a title, from those meetings, it would be ‘Nobody Is Happy.’”
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