TradeTech FX USA 2015 (past event)
January 26 - 27, 2015
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Trade-At Rule - Sell Side Firms Prepare For Big Changes
In this exclusive presentation, Hal S. Scott, Director, Committee on Capital Markets Regulation, Nomura Professor and Director, Program on International Financial Systems, Harvard Law Schooldiscusses trade at rule: What Will Be Implemented and How Will It Influence Market Structure? Which provisions will have the biggest impact?
According to the SEC's proposed trade-at rule, sell side firms would be unable to internalize trades unless they could provide a half-cent price improvement over the market's best price. The rule takes a swipe at dark pool trading, which makes up about 30 percent of the market, and attempts to shift more trading to public venues. The rule would give individual investors a better opportunity to determine best prices based on buying and selling interest.
Investment firms argue that the trade-at rule would hurt investors because cost increases would be passed on to investors. Many retail investors may actually get better prices when brokers sell stock out of their own inventory. Also, many passive limit orders have access fees attached to them. If firms had to route more transactions into public exchanges, then they would have to pay more access fees. The costs would be passed on to customers in the form of higher commissions.
At the same time, price improvement may present problems for those holding liquidity on the open market. For instance, if an investor has a visible passive limit order, a market maker may step in front of that trade to execute a price improvement. While the market maker's customer did receive a slightly better deal, the retail investor who could not execute the trade incurs an unquantifiable cost.
The price improvement for the firm does not justify the cost of missing execution for the retail investor. In most cases, retail investors are not savvy enough to know about the opportunity that they lost. Expecting firms to price improve by a half-cent will make the savings for each firm's customers more substantive. However, that price reduction does not ultimately justify the loss to the retail investor.
The trade-at rule will keep firms from stepping in front of passive limit orders for mere fractions of a penny. Also, the rule would make bring the NBBO back to a first-come, first-served basis. Firms could fill orders from the open market first and then complete orders from their own inventory. This solution would greatly benefit the liquidity provider. By decreasing action in the dark pool, the rule would also create more competition in the open market. Market participants would have to price more aggressively and show quotations in larger sizes, which would both lower spreads and increase liquidity depth.
According to the SEC's proposed trade-at rule, sell side firms would be unable to internalize trades unless they could provide a half-cent price improvement over the market's best price. The rule takes a swipe at dark pool trading, which makes up about 30 percent of the market, and attempts to shift more trading to public venues. The rule would give individual investors a better opportunity to determine best prices based on buying and selling interest.
Investment firms argue that the trade-at rule would hurt investors because cost increases would be passed on to investors. Many retail investors may actually get better prices when brokers sell stock out of their own inventory. Also, many passive limit orders have access fees attached to them. If firms had to route more transactions into public exchanges, then they would have to pay more access fees. The costs would be passed on to customers in the form of higher commissions.
At the same time, price improvement may present problems for those holding liquidity on the open market. For instance, if an investor has a visible passive limit order, a market maker may step in front of that trade to execute a price improvement. While the market maker's customer did receive a slightly better deal, the retail investor who could not execute the trade incurs an unquantifiable cost.
The price improvement for the firm does not justify the cost of missing execution for the retail investor. In most cases, retail investors are not savvy enough to know about the opportunity that they lost. Expecting firms to price improve by a half-cent will make the savings for each firm's customers more substantive. However, that price reduction does not ultimately justify the loss to the retail investor.
The trade-at rule will keep firms from stepping in front of passive limit orders for mere fractions of a penny. Also, the rule would make bring the NBBO back to a first-come, first-served basis. Firms could fill orders from the open market first and then complete orders from their own inventory. This solution would greatly benefit the liquidity provider. By decreasing action in the dark pool, the rule would also create more competition in the open market. Market participants would have to price more aggressively and show quotations in larger sizes, which would both lower spreads and increase liquidity depth.
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