Enhancing Our Equity Market Structure
SEC Chair Mary Jo White speaking at the Sandler O’Neill & Partners, L.P. Global Exchange and Brokerage Conference in New York, N.Y.
It is great to be here with you in New York to speak about our equity market structure and how we can enhance it.
While I know your views on particular issues may differ, you all certainly appreciate that investors and public companies benefit greatly from robust and resilient equity markets.
During my first year as Chair, not surprisingly, I have heard a wide range of perspectives on equity market structure, reflecting its inherent complexity, the relationships among many core issues, as well as the different business models of market participants. To frame the SEC’s review of these issues, I set out last fall certain fundamentals for addressing market structure policy. One of those is the importance of data and empirically based decision-making. At that time, we launched an interactive public website devoted to market structure data and analysis drawn from a range of sources. The website has grown to include work by SEC staff on important market structure topics, including the nature of trading in dark venues, market fragmentation, and high-frequency trading.
Through this initiative and others, we have taken important steps to further strengthen the investing environment. And today, as we move forward in the next phase of our efforts to enhance our market structure, I am recommending additional measures to further promote market stability and fairness, enhance market transparency and disclosures, and build more effective markets for smaller companies. I am also recommending to the Commission the creation of a new Market Structure Advisory Committee of experts to review specific initiatives and rule proposals. Your input also remains essential to help us ensure that our markets continue to operate openly, fairly, and efficiently to benefit investors and promote capital formation.
I. Taking Principled Action
Let me start with the core principles that are grounding our review of equity market structure and guiding further actions.
First, we must evaluate all issues through the prism of the best interest of investors and the facilitation of capital formation for public companies. The secondary markets exist for investors and public companies, and their interests must be paramount.
Second, we must account for the varying nature of companies and products, with a particular sensitivity to the needs of smaller companies. One market structure does not fit all.
Third, our review of market structure must be comprehensive. We must test our assumptions about long-standing rules and market practices. Past decisions must be reevaluated in light of current conditions, and market-based solutions to issues should be explored. Barriers to such solutions must be reviewed, and removed where appropriate.
II. Market Structure Today
Equity markets are, of course, now dominated by computer algorithms, which generate orders at a volume and speed that have transformed the nature of trading. Importantly, these algorithms are used not only by high-frequency traders, but also by or on behalf of investors.
Empirical evidence shows that investors are doing better in today’s algorithmic marketplace than they did in the old manual markets.
For institutional investors, the costs of executing large orders, measured in terms of price, were more than 10% lower in 2013 than in 2006. This is true even though fundamental volatility — which in general is positively correlated with such costs — was slightly higher in 2013 than it was in 2006.
The level of intraday volatility also has returned to low levels after spiking during the financial crisis. Intraday volatility of the S&P 500 Index was nearly the same in 2013 as it was in 2006 — for both average and maximum volatility.
The spreads between bid and ask prices for the broader market also are as narrow as they have ever been. These narrower spreads are particularly important for retail investors because they reflect the cost of trading immediately at the best prices, which is generally the objective of retail investors.
All of these market quality metrics show that the current market structure is not fundamentally broken, let alone rigged. To the contrary, the equity markets are strong and generally continue to serve well the interests of both retail and institutional investors. The largely positive data on broad market quality does not mean, however, that the current market structure is without issues.
Some potential additional benefits for investors from improved technology may have been diverted by excessive intermediation, and broad market quality would perhaps be even better if different rules were in place.
And not all segments of the equity markets have equally shared the benefits from the positive market trends, and that disparity may have increased in recent years. For example, key costs for institutional investors in small-cap stocks appear to have remained relatively high since the financial crisis, in contrast to the large declines in such costs for the broader market.
As a general matter, many market structure rules and industry practices were developed with manual markets in mind. They cannot be expected to optimally address all of today’s market practices.