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Schapiro on Evolving Equity Market Structure

In a September 7, 2010 address before the Economic Club of New York, SEC Chairman, Mary L. Schapiro spoke of the rapid changes in the equity market structure, and ways in which the SEC is working to strengthen it. According to Schapiro, the most significant changes in the equity market structure in the past few decades have been the introduction of electronic trading markets, the speed in which trading takes place, and the movement of a large volume of equity trading from listed exchanges to public exchanges, dark pools, and internalizing broker-dealers.

A decade ago, most of the volume in stocks was executed manually, either on the floor of an exchange or on traders' desks. Now, nearly all orders are executed by fully automated systems at great speed. The fastest trading venues are now able to accept, execute, and send a response to orders in less than one thousandth of a second. Sophisticated trading firms can process market information, generate buy or sell orders, and send them to an exchange in less time than it takes to blink your eye.

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Today, the NYSE executes approximately 26 percent of the volume in its listed stocks. The remaining volume is split among more than 10 public exchanges, more than 30 dark pools, and more than 200 internalizing broker-dealers. Indeed, today, nearly 30 percent of volume in U.S.-listed equities is executed in venues that do not display their liquidity or make it generally available to the public.

These rapid and widespread changes to the nature of equities markets have raised many concerns. Schapiro stated that, in response, the SEC has issued a concept release broadly requesting comments from market participants on ways to better regulate and improve equity markets. According to Chairman Schapiro, some of the concerns raised in the public comments go to the very core of the equity market structure:

[T]wo concerns that go to the core of our equity market structure: First, whether the quality of price discovery has declined, and second, whether these changes in our market structure could undermine the fair and level playing field essential to investor protection, capital formation and vibrant capital markets generally.

Other comments show dire concerns about the "Flash Crash" of May 6, its causes, and resulting worrisome investor behaviors.

Many individual investors, for example, have submitted comments to the Commission that are highly critical of the current market structure.  Retail broker-dealers have told us that their customers - individual investors - have pulled back from participating in the equity markets since May 6.  Indeed, according to mutual fund data, every single week since May 6 has seen an outflow of funds from equity mutual funds.

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Institutional investors, also have expressed serious reservations about the current equity market structure. At our June roundtable discussion of market structure issues, several institutional investors questioned whether our market structure meets their need to trade efficiently and fairly, in large size.

Their views were shared by many respondents to a survey that was submitted as a comment letter on the market structure roundtable.  Less than 50 percent of the buy-side respondents, for example, expressed confidence in the current market structure. When these professionals - representing the interests of many millions of individuals who invest indirectly in the equity markets - express concern in the U.S. equity market structure, we must listen closely.

Schapiro outlined steps the Commission has taken to begin to address these concerns, in addition to its January concept release.

It falls to the SEC to ensure that the rules governing market structure and market participant behavior foster fair, reliable and resilient markets that warrant the full confidence of investors and listed companies. The SEC already has taken a number of important steps to further this goal.

  • We have proposed rules that would effectively prohibit broker-dealers from providing third-parties with unfiltered access to the markets and require that broker-dealers implement appropriate risk controls for market access.
  • We have proposed large trader reporting requirements and a consolidated audit trail system that would tremendously enhance regulators' ability to identify significant market participants, collect information on their activity, and analyze how their trading behavior affects the market.
  • We have proposed to ban the display of flash orders that may give an inequitable advantage to certain traders, and to prevent information about buying and selling interest in dark pools from being made available only to a select group of participants in the pools.

Chairman Schapiro stated that these regulatory actions are only a start, and that the Commission would be delving into, and thinking deeply about four major areas of concern:

First, we should reexamine the circuit breaker mechanisms that directly limit price volatility. These include the recently adopted circuit breakers for individual stocks, as well as the longstanding broad market circuit breakers that apply across the securities and futures markets.   A second area that warrants close review is the regulatory scheme that applies to the most active and sophisticated participants in today's market structure — high frequency trading firms.  A third type of trading practice that has received recent attention involves submitting large volumes of orders into the markets, most of which are cancelled.  Finally, there is market fragmentation.

With reforms in these areas, Schapiro stated that she feels confident that the equity markets will keep pace with changing market participant behaviors, as well as rapidly changing trading technologies and volumes.

The full text of Chairman Schapiro's September 7, 2010 speech is available at: