Texas Stock Exchange, Reg NMS, and broken US equity market structure Two weeks ago, it was announced that the Texas Stock Exchange, backed by BlackRock and Citadel, would aim to become the 16th national securities exchange for trading US equities. This news serves as a backdrop for the below discussion of problems with today’s US equity market structure. The SEC’s Regulation National Market System (Reg NMS) requires that all US equities trades be executed at a price equal to or better than the National Best Bid or Offer (NBBO). The NBBO is computed based on the best prices displayed on all of the “lit” exchanges, i.e. the venues that are registered with the SEC as national securities exchanges. There are currently 15 such exchanges. To comply with Reg NMS as a broker-dealer or exchange, one must pay for and subscribe to the market data feeds of every lit exchange, or else pay Nasdaq or NYSE for their SEC-sanctioned consolidated NBBO feeds (which indirectly pays each exchange). The yearly costs for these subscriptions run in the high 6-figures, even 7-figures if subscribing to the fastest order-by-order feeds from these exchanges, such as Nasdaq’s FPGA ITCH feed. As Matt Levine and Katie Greifeld discussed on last week’s Money Stuff podcast, once TXSE becomes a regulated lit exchange, every broker-dealer will be required to subscribe to TXSE’s marketdata either directly or indirectly, a guaranteed income stream for TXSE even if it ends up with no meaningful trading volume. Competition in markets through multiple trading venues is generally good. But this regulation-subsidized arrangement results in a proliferation of trading venues with often little differentiation between them, other than listing standards and fee structure (inverted vs maker-taker, etc.). For brokers or exchanges that perform NMS-compliant order routing on behalf of customers, there are especially high operational costs from having to connect to each exchange directly and implement each exchange’s particular order protocol (Nasdaq OUCH, Cboe BOE, NyseArca Pillar). The regulatory burden and operational overhead are in part why so many banks, trading firms, and other entities have created their own Alternative Trading Systems (ATSs) for executing US stocks. These ATSs are not included in NMS because they do not display their quotations or order books (and are referred to as “dark” venues, or “dark pools”). There are dozens of both registered and unregistered ATSs with potential sources of liquidity. In order to source the best possible price in the market, brokers pay for and maintain connections to a large number of these dark venues in addition to lit exchanges. (Continued in comments)
Broken? Let’s see: it is the most liquid, largest, highest volume, greatest number of participants of all stripes, highest capitalization, strongest standards of conduct and transparency with institutional investors from around the world constantly shedding other investments to participate. Is the structure truly broken, or do you just happen not to be fond of those who are able to extract profits from the structure as it exists today?
Adam Baitch
4w
Another result of this is that Market Data in the United States is essentially a regulation-enforced oligopoly. For example, broker/dealer FinTechs operating in the US have to show traders the NBBO when they’re about to execute a trade, however many of them will limit their costs by showing users cheaper, more limited “last sale” price feeds when they’re just browsing an app and looking at stock prices. Still, the highest quality price feeds are all owned by the the three largest exchange groups (NYSE, NASDAQ and CBOE). Because these three collectively own the vast majority of "lit" trading market share (~15-20% each) they have immense pricing power for "good" data. There are alternative feeds from smaller exchanges, but you'll often have to implement clever guardrails to ensure your users are seeing something reasonable. In my experience, this can be a huge time-suck for in-house teams, though it's something that some re-distributors can alleviate. When it comes to picking one, FinTechs often want to strike a balance between quality and price, and will consider different options for different parts of their product or different phases of their growth.
Jim Bentley
4w
not to mention public trust in Citadel and Blackrock is, well, let's say 'less than ideal' - smells like potential crime under a guise.... in my opinion
Tim H.
3w
sure. just what the planet needs. another exchange. how about we try allowing access to existing foreign exchanges for the small investor first? or allow everyone with a computer to open an exchange? how did multiple, regional exchanges work out in the past?
Founder and CEO, Architect
4wThe natural consequence of this structure is the emergence of equity wholesalers: trading firms that perform the work of connecting to many exchanges, consolidating marketdata, and sourcing liquidity in exchange for exclusive access to a downstream broker’s retail order flow. The top firms in this category are Virtu, Citadel Securities, G1S, Two Sigma, and Jane Street. These firms allow retail brokerages to keep commissions at zero (or often negative) by taking on all of the burdens associated with Reg NMS. On the other hand, many retail traders, trading institutions, and even the SEC themselves have expressed concern about the migration of liquidity from the public, lit markets to these dark, single-dealer platforms. It’s hard to imagine the introduction of TXSE, a 16th regulated NMS venue in an already vast network of exchanges and ATSs, would make a significant impact on US equity market structure aside from establishing new listing standards. Its introduction does serve as a reminder of the unintended consequences of Reg NMS.