Highlights from the IAA/CMS Trading and Best Execution Summit:
Market Structure Changes and IAs’ Trading, Best Ex Obligations
June 24, 2020
The IAA’s second annual Trading and Best Execution Summit, cosponsored by Capital Markets Strategies, took place on June 18 in the midst of sweeping SEC initiatives designed to bring significant change to market structure and trading in the United States. The virtual event – attended by more than 300 mostly buy-side professionals – focused on how regulatory changes are likely to affect how investment advisers approach and manage their trading and best execution obligations and governance.
Those regulatory changes relate to trade transparency, how information flows from exchanges to the public, and governance of securities information processors (SIPs). Panelists also focused on the management of trading technology and data and automation and developments in the equities, fixed income, and ETF markets.
SEC Commissioner Hester Peirce, Brett Redfearn, the current director of the SEC’s Division of Trading & Markets (T&M), and a panel of former T&M directors led by FINRA’s Chief Legal Officer Bob Colby – himself a former T&M director – headlined an impressive roster of more than 30 industry and regulatory speakers.
The impact of COVID-19 on the markets and the SEC’s response highlighted Peirce’s remarks in her keynote conversation with IAA General Counsel Gail Bernstein. Peirce also addressed the SEC’s work on equity market structure and implications for the buy-side. In remarks that would be echoed by speakers throughout the day, Peirce expressed some concerns about liquidity in the fixed income and credit markets during the pandemic, but praised the resilience of the equities markets, which bounced back well from several trading halts in March when circuit breakers were triggered.
“…Peirce said that firm failure is the right result for trading algorithms going wrong – the incentive should be with a firm to pay attention to what its algorithms are doing.”
She also discussed the SEC’s ambitious proposal to amend the rules that govern the collection, consolidation, and dissemination of data on national market system (NMS) stocks. Responding to questions about the first major proposal to revamp market data infrastructure since Regulation NMS was adopted in 2005, Peirce said she is hopeful that the SEC will be able to address concerns about the content, quality, and speed of trade data that flows to the buy-side, while also addressing conflicts within and encouraging greater competition among SIPs. With respect to competition, Peirce said that firm failure is the right result for trading algorithms going wrong – the incentive should be with a firm to pay attention to what its algorithms are doing.
Peirce touched on the recent Court of Appeals ruling that overturned the SEC’s transaction fee pilot, one of the initiatives the SEC undertook in late 2018 to address trading-related conflicts. She suggested that the Commission “has other things in the works” to address its concerns with exchange transaction fees. She also discussed her dissent from the Commission’s amendments to the Consolidated Audit Trail (CAT), warning of vast cybersecurity risks and threats to individual liberty if people can be “followed around in the marketplace” even when engaged in routine market activity.
“The SEC believes in transparency, said Redfearn. Brokers should be providing more uniform data, ‘apples-to-apples,’ to all buy-side clients.”
In his “fireside chat” with Capital Markets Strategies President Ari Burstein, Redfearn elaborated on many of the themes addressed by Peirce, focusing his remarks on the importance of addressing conflicts, increasing the public’s access to data, and fostering competition while ensuring protection of investors. The SEC believes in transparency, said Redfearn. Brokers should be providing more uniform data, “apples-to-apples,” to all buy-side clients. He also opined that the change in the SIP business model from not-for-profit to for profit created a significant conflict, which may explain why the evolution of SIP governance has lagged. He called for broader participation in SIP governance, including by having a seat at the table for the buy-side.
Redfearn also noted the resilience of the equity markets during the volatility of the early days of the COVID disruption, saying that while the Commission may need to “tweak” circuit breakers, it is unlikely that it will conclude that there are “burning issues” to fix. Panelists throughout the day generally agreed that the markets have fared well during the pandemic. Several credited market participants’ investment in technology in recent years. At least one panelist questioned the wisdom of short-selling restrictions, which went into effect in many non-U.S. jurisdictions, suggesting that these restrictions in fact have a negative impact on the ability of market makers to hedge risk, thereby resulting in higher costs for investors.
One of the clear highlights of the summit was the panel of former T&M directors, featuring Brandon Becker, Richard Lindsey, Steve Luparello, and Annette Nazareth. Moderator Bob Colby engaged the panel in a lively back and forth on holistic versus incremental market change (all said that holistic does not work), how the SEC should react to the court’s transaction fee pilot decision (do you collect data or accept that fees are suboptimal and address them directly?), differences between the equity markets (they are well-priced, liquid, and accessible) and the debt markets (as they become more accessible to retail investors, their structural and pricing issues become more significant), and how to think about market structure and best execution in the fixed income markets.
The several other panels took up these same themes, looking at them from the different perspectives of the buy-side, sell-side, and regulators. The discussions focused heavily on the increasingly important role of data, not only with respect to how best to obtain, manage, contextualize, and understand it, but also its importance in selecting trading counterparties. Panelists discussed how advisers, especially smaller advisers, should become more versed in how vendors can help them with the ever-growing amount of available trading data, particularly in the areas of transaction cost analysis and order routing information.
Best execution, panelists felt, should remain principles-based rather than prescriptive. But they also generally agreed that regulatory guidance and clarity around regulatory expectations are important. Panelists Louis Gracia, Associate Director of the SEC’s Chicago Regional Office, and Stephanie Dumont, Senior Vice President and Director of Capital Markets Policy at FINRA, discussed best execution obligations as well as steps regulators have taken to help markets and market participants during the pandemic. With respect to SIP governance, many panelists felt that consumers of trade data should have a say through voting rights on the process of how they receive the data and what the data includes. As for competition, some panelists thought that increasing the number of entrants into the markets increases efficiencies and is ultimately good for investors, while others worried that the proliferation of trading platforms is bound to bring with it new conflicts and complexities.
Echoing concerns expressed by the SEC panelists, other panelists agreed that the regulatory focus on equities has left the fixed income markets more vulnerable, especially for retail investors where costs tend to be higher than for institutional investors. Several panelists over the course of the day called for greater regulatory attention to the fixed income markets. The last panel of the day, moderated by IAA Associate General Counsel Monique Botkin, squarely addressed the challenges in measuring best execution in fixed income. It discussed different tools, technology, and protocols that could help the buy-side understand pricing and liquidity in fixed income trading and shared observations on data governance and transparency in these markets.
Recordings and presentation slides from two April IAA webinars – Best Execution & Trading in the Equities Markets in the Current COVID-19 Environment and Best Execution & Trading in Fixed Income and ETFs in the COVID-19 Market Environment – are available free to IAA members and Associate Members on the IAA website’s Webinars pages.
In related developments, SEC Chairman Jay Clayton and Redfearn discussed many of the same issues related to U.S. equity market structure in remarks at a June 22 SEC virtual forum on modernizing U.S. equity market structure. That same day, the SEC signed a Memorandum of Understanding (MOU) with the Department of Justice that establishes a framework for the SEC and the DOJ’s Antitrust Division to continue regular discussions and review law enforcement and regulatory matters affecting competition in the securities industry, including evaluating exchange proprietary data fees. Clayton stated his intent to use the new MOU to coordinate with DOJ staff where necessary to benefit from their views on certain competitive theories to help the SEC assess whether the exchange fees are consistent with Exchange Act obligations.
TAGS: Trading, Best Execution, COVID-19, Coronavirus, Hester Peirce, Brett Redfearn, Jay Clayton