U.S. securities rules could still roil exchanges
Tue Feb 27, 2007 10:38am ET
By Jonathan Keehner
NEW YORK, Feb 27 (Reuters) - Despite exhaustive preparation, sweeping changes to U.S. equity markets taking effect next month could further rock the nation's once quiet financial exchanges sector, already swept by a wave of consolidation.
Designed to modernize markets through automated trading, Reg NMS -- for National Market System -- has precipitated moves like a new stock exchange launched by options mart International Securities Exchange (ISE.N: Quote, Profile , Research).
It also spawned NYSE Group's (NYX.N: Quote, Profile , Research) hybrid platform, which for now weds traditional floor-based brokers with new electronic capabilities, but many believe could be the death knell for open outcry trading.
"While Reg NMS has already produced a historic shift by making the New York Stock Exchange convert to an automated market, there is the potential for unintended consequences that none of us are seeing," said Nasdaq Stock Market (NDAQ.O: Quote, Profile , Research) Executive Vice President Chris Concannon. "Or that someone out there has seen but the market doesn't yet appreciate."
In no less than 371 pages the regulations, instituted by the U.S. Securities and Exchange Commission, span four major areas and call for executing automated orders at the best available price, open access to quotations across market centers, consistent pricing increments and new rules for disseminating market data.
With such a broad mandate, experts say that regardless of everything to anticipate Reg NMS, the rules could have unseen consequences as they fully take effect this year -- leading to new models or industries in the increasingly for-profit business of exchanges and equity trading.
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The regulations could shake up equity markets through the Market Data Rule, analysts say, which allocates the distribution of revenue from fees paid by broker-dealers for market data.
Under prior rules revenue was divided based on the number of shares executed -- incentivizing markets to break orders into smaller increments, for which they received more data revenue in a scheme the SEC called "trade shredding."
Reg NMS tries to correct this by dividing revenue on both the number of completed trades as well as quotes posted at the best price.
"The recalculation of the market rebates will definitely have some very interesting unintended consequences," said Adam Sussman of New York consultant Tabb Group. "Pre-NMS you got paid for trades but part of post-NMS is getting paid just for quoting."
With stock price quotations offered by markets at ever-increasing speeds, it may be possible to enter and remove a quote before it could be accepted. Trading venues could generate revenue for orders with a limited chance of execution, said Sussman, causing a spike in quoting activity.
"Venues could incorporate that in their business model," he added. "If they do the SEC will of course take a look but it will be an interesting wrinkle in the development of Reg NMS."
Unintended consequences may also come from connecting markets after Reg NMS, says Keefe, Bruyette & Woods analyst Richard Herr, adding that a decade ago few anticipated the rise of electronic communication networks (ECNs) following regulations called Order Handling Rules.
Those rules, a response to charges of collusion among brokers, ushered in a new era of competition and combinations between exchanges and ECNs like Archipelago and Island.
Reg NMS could take equity trading on a similarly unexpected turn as markets are forced to execute automated orders at the best available price, leading to a focus on efficiently sending orders between venues. This could ignite competition around providing links to exchanges and other markets, says KBW's Herr.
Indeed, stock exchanges have signaled their intention to pull out of the current linkage system, governed by the nearly 30-year-old Intermarket Trading System (ITS), suggesting demand for new products that interconnect markets once Reg NMS is unrolled this year.
With new trading venues announced regularly but a limited number of third-party linkage providers available, Reg NMS may spawn a spirited industry around connecting markets that must be aware of prices available nationwide.
"The ability to route orders is a service that every exchange is going to have to provide to be NMS compliant," said NYSE Vice President Colin Clark. "Exchanges will be offering private routers and within that service there is room for enhancement." |
