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In a market structure-focused research report published today, Larry Tabb, founder and CEO of TABB Group, the capital markets research and consulting firm, addresses the need to rethink how markets should operate and tweak, or even scrap, Regulation National Market System (Reg. NMS) that so many institutions have come to loath.
It has been six years since Reg. NMS went into effect, says Tabb, an expert in market structure issues, who frames the contentious debate on the SEC’s 2006 regulation in “Regulation NMS Part I: Loved or Loathed and Why Many Want it to Die.” “We have enough data and history to make a reasonable assessment if Reg. NMS actually created the market we wanted, if its goals were actually met or if the unintended consequences of Reg. NMS were too great for their benefits.”
Tabb examines the major Reg. NMS themes – execution times, trade-through protection, sub-pennies and the methodology in which market data fees were assessed and rebated which caused market participants to “shred” trades – as well as a number of lesser but no less important issues: speed, the new currency; ISO orders; and top vs. depth of book.
After Reg. NMS was implemented in 2007, TABB Group estimated peak spread capture from high-frequency trading (HFT) in the US in 2009 was approximately $7.2 billion. For 2013, TABB estimates that number to be $1.1 billion. While some of this lack of capture comes from reduced volumes and lack of volatility, Tabb says a significant portion of this reduction can be attributed to the increased sophistication of anti-gaming logic built into execution algorithms to protect customer order flow. “If today’s rules were significantly changed, we anticipate that in the short and possibly intermediate term, institutional investors’ performance would be negatively impacted.”
He cautions, however, “that while we believe theoretical and practical research should be performed consistently on our markets, the industry as well as Congress and regulatory officials need to be careful in changing how our markets actually work. Markets need guidelines and rules that should be policed – but constantly tinkering with rules can create some very significant unintended consequences.”
While change is hard, Tabb says, “the time has come to debate Reg. NMS, to ask the right questions, determine priorities, develop fair rules and implement pilot programs to gather the right data, analyze it in controlled and meaningful ways and create a discussion not only how to develop the right market structure but how to implement them as well.”
Editor’s Note: In March 2012, the US Commodity Futures Trading Commission selected Tabb to assist their CFTC Technical Advisory Committee as a member of its Subcommittee of Automated and High Frequency Trading (HFT). In September 2012, he was invited by the US Senate Committee on Banking, Housing and Urban Affairs to testify at the Senate Subcommittee on Securities, Insurance and Investment session on “Computerized Trading: What Should the Rules of the Road be?”, chaired by Senator Jack Reed (D-RI).
The 17-page research note with 5 exhibits is available for immediate download by TABB Group Research Alliance Equities clients and pre-qualified media. For the Executive Summary or to purchase the report, see http://www.tabbgroup.com/PublicationDetail.aspx?PublicationID=1302 or write to info@tabbgroup.com.
The second part of the series, “Reg NMS, Plugging the Gaps: Where You Stand Depends on Where you Sit,” will be published soon.
