I applaud the SEC for its courage to propose NMS governance structure reform even as the large exchange groups hold tremendous voting power in the Equity Data Plans. I have no objection to the Commission’s proposal, because the root cause of today’s equity market data problems is the unclear delineation of rights between exchanges, which sell market data, and trading firms, which generate that data. And I agree that the transformation of the exchanges into publicly owned companies and the emergence of exchange groups controlling multiple venues exacerbate the conflicts-of-interest issue.
The Commission’s proposed amendments to the Consolidated Tape Association Plan (CTA); the Consolidated Quotation Plan (CQ); and the Joint Self-Regulatory Organization Plan Governing the Collection, Consolidation, and Dissemination of Quotation and Transaction Information for Nasdaq-Listed Securities Traded on Exchanges on an Unlisted Trading Privileges Basis (UTP) are aimed at striking an appropriate balance between respecting the autonomy of exchanges and improving best practices to advance the NMS-related governance structure.
Despite the fact that securities exchanges registered with the SEC as self-regulatory organizations (SROs) are quasi-regulatory authorities, SROs do not enjoy quasi-governmental immunity. Thus, I am not sure whether the SEC can force the large exchange groups administratively to accept the proposal as is; the large exchange groups are likely to fight back. That said, I have long advocated for splitting up exchanges’ listing/trading businesses from their data business to replace the distorted economy of scope with efficiency gains from fewer fights and more cooperation among trading venues and better economy of scale.
The spinoff of the Securities Information Processor (SIP) business from the securities exchanges is fair to everyone because it relies on market mechanisms to determine a settlement price for rights that SROs may willingly give up. This saves the hassle to re-design and maintain a fair and reasonable revenue allocation formula for distributing plan revenues, as participants’ voting rights are also going to be reallocated under the SEC’s proposal. The exchanges will have no excuse not to accept this “split” – if they do not even trust the market mechanism that they themselves operate in for a fair price, then how they will be qualified to tell others to trade on their platforms?!
Another key advantage of “spinning-off” the SIP is that it avoids potential litigation fights that delay the implementation of some of the governance best practices proposed by the SEC. There would no longer be challenges to overcome dominate voting blocks held by the exchanges. In turn, the SIP, under new management, can accelerate decision-making on advancing the SIP’s performance and price competitiveness with exchanges’ proprietary products.
That said, this is under the condition of mandating the use of time-lock encryption for both the SIP’s consolidated data and exchanges’ proprietary feeds. As mentioned in my submitted comments and meeting with the SEC in December 2019, the interpretation of 17 CFR §242.603(a) is incomplete and requires clarification or appropriate updates. “Transmitting or releasing data no sooner than to a Network processor (SIP)” only describes one of the aspects of “fair and reasonable” and “not unreasonably discriminatory” principles required by Reg NMS. It omits the fact that market data is highly valuable (it reflects the price discovery created by exchanges) and it requires proper security protection.
Hence, the secured delivery (in motion and at rest) and retrieval of data in a timely manner are equally important. Time-lock encryption is a method to encrypt data such that it can only be decrypted after a certain deadline has passed. The goal is to protect data from being decrypted prematurely. So, regardless of when data is transmitted, everyone, including subscribers of exchanges’ proprietary products, would only be able to start decrypting when the clock strikes to allow data decryption at the SIP.
I already obtained patent approval on using Time-Lock Cryptography (TLC) to address this market data and market access problem. Rest assured this is not another speed bump. More important, the approach eliminates the issue (i.e., the market will not fix the market because of SROs’ rivalry and rent seeking behaviors) identified by Eric Budish, Robin S. Lee, and John J. Shim’s empirical research.
The successful design of TLC depends on accuracy and precision to calibrate any nuances as well as the amount of computational resources to decrypt the data. Because we do not want to create an arms race of using high-performance computers to decrypt the data, computational resources and the type of data contents also must be considered in the design of a reliable encryption scheme. In order level the race to decrypt/decode data, my patented approach enables trade activities to be transformed into musical piece representation and metrical trees that make it possible to leverage Lossy compression methods, such as MP3, to yield a substantially greater compression ratio (60% or more of the original stream) as compared to traditional techniques (only 5-20%) that exploit statistical redundancy, Huffman coding, or probability method to represent and compress market data. My methods reduce data storage and boost the efficiency in data distribution, while also enabling the replication of full depth-of-book (DOB) information. Consequently, we are able to best preserve the richness of the data contents, while making the tool fast, easy, secure and fit for solving the market data and market access problem.
This brings us back to the point of why “spinning-off” the SIP is better than prescribing a particular governance structure and continuous arguments over voting rights. With the SIP under new management, it can quickly adopt new approaches, such as TLC and MP3, to benefit the industry.
In additon, per my submitted comments to the SIP operating committee, market authorities and the overall industry must recognize that, because of the immutable latency issue, there has to be some give and take to optimize the balance between processing speed and the content richness of the SIP. I encourage the industry to consider the following suggested priorities:
(i) First, address the speed differentials between the market data feeds provided by the SIPs and the proprietary products sold by the exchanges in order to get the biggest bang for the buck.
(ii) Second, demand full depth-of-book information (a replication of the relative strengths in bid-ask price and steepness of the price curve in real-time), so at least the content would be a bit more compatible with the proprietary products sold by the exchanges, while minimizing drag on the SIP processing speed.
(iii) Third, pursuit market structure changes outside of the SIP that will make odd lots become true “outliers” (Instead of bluntly getting rid of odd lots by changing the round lot size, one should ask what are the various reasons for the existence of odd lots. For example, the causes related to a lack of stock split, the segment’s specific needs in moving blocks under the impending dynamics between lit and dark venues, etc.) rather than the “norms”, and/or ask for “delayed” odd lot trades and quotations statistics, so that experienced market participants may use reverse-engineering methods to “figure-out” or “project” how these odd lots would play out in sequence. This “alternative”, “compromise”, or “trade-off” is based on the condition of Exchanges willingness to adopt point (i) above – making market data available securely in synchronized time.
Click here to see my full 20-page comments submitted to the SEC.
Last but not least, be careful what you wish for in asking the SEC to tell you how to govern. Certain steps would likely create bureaucracy, adding unnecessary regulatory burden. If rules are too prescriptive, it would affect private practices. Guidelines and procedures may never be comprehensive enough and regulators should not be in the position to judge these private practices or step in every time when there are disputes among stakeholders. It would be impossible to put the genie back in the bottle when regulators’ interference powers grow and be used (or abused) for political purposes. If there might be dysfunctional party, let them “off-the-bus” by spinning off SIP.
