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Debate Continues on the US Equities Market Structure Front: Insights from “Impact of Reg NMS II on Exchanges, Market Surveillance and Order Routing”

Debate Continues on the US Equities Market Structure Front: Insights from “Impact of Reg NMS II on Exchanges, Market Surveillance and Order Routing”

On Wednesday, July 1st, we held a Reg NMS II webinar hosted by our CEO, Travis Schwab with special guest speaker, Adam Inzirillo, Head of Equities at Cboe Global Markets.

We kicked this off with a game to spice things up for our audience. Every time either Travis or Adam would say “unintended consequences” or “undue complexity,” the audience would have to drink.

For the record, Travis said the word “complexity” or “complexities” five times while Adam said it eight times. With that, there is a good chance that our audience could have been two sheets to the wind if they followed the rules.

For those who may be interested, there is a replay of this webinar at the end of the blog.

Now, to the meat of the event…


Macro View of Today’s Market: What’s Working and What’s Not

Since the late 1990s, the US equity markets have evolved tremendously and today they are deemed fairly efficient and transparent.

Over the past couple of months, while the industry grappled with the onset of COVID-19, the equity market centers remained resilient in the face of increased trading volume and volatility cast. This is thanks in part to several regulations that helped pave the way post-Financial Crisis, Flash Crash and beyond, helping to navigate us through volatile times, including:

  • Rules 201 & 204, focused on short selling and close-out requirements, respectively
  • Limit Up-Limit Down (LULD), implemented to prevent trades in National Market System (NMS) securities from occurring outside of specified price bands
  • Reg SCI, enacted with the aim of strengthening the technology infrastructure of the markets

On the flipside, while there was agreement the markets function pretty well in general and that regulatory actions and the pain involved to comply with all the changes have paid off based on the markets’ operational performance as of late (in equities and elsewhere), as for what could be improved upon, in March and April, we saw four different market-wide circuit breakers take place. As a result, the industry will likely look for ways to improve on that, especially as it pertains to circuit breakers triggering at the open.

But other than a couple tweaks to this process, no major changes are deemed necessary nor foreseen at this point, and certainly not anything overly intrusive along the lines of a sweeping reform like MiFID II.


Reg NMS and Transparency

By way of background, Reg NMS was first proposed in 2003, amended in 2005 and implemented in 2007, and is focused on market data infrastructure to make markets more efficient and electronic.

It was designed to protect the public market, but debate continues on whether the market still needs protection.

As the discussion touched several times on the theme of transparency, examples of regulatory bodies getting it right was the enactment Reg ATS-N, along with the amendments to Rule 606, which increase the transparency of alternative trading systems and handling of orders by broker-dealers, respectively.  It was suggested that Rule 605 also get a refresh to go along with the updates made to Rule 606.

Continuing on this theme, there was talk of the need for additional transparency into all market centers, including non-ATS vehicles like single-dealer platforms, or SDPs.  Here again, though, the suggestion was to take smaller steps to afford market participants a better view into the operation of these market centers rather than putting something in place more onerous and intrusive.


PFOF and the Exchanges’ Ongoing Battle to Level the Playing Field

As the discussion turned to retail and PFOF (payment-for-order-flow), the panelists pointed to the considerable consolidation of available outlets for retail trading flow since the majority is now going to only a handful of wholesale market makers. Many in the industry have long questioned the practice of payment-for-order-flow, which is the compensation a retail brokerage firm receives for directing customer orders to various parties (usually the wholesale market makers) for trade execution. Recently, the retail trading app Robinhood found itself in the headlines after certain outlets sounded the alarm about disclosures that it sells its order flow to these wholesale market makers, along with some sensational claims in these stories as to how this process works and the related implications.

But this is – and it has been for years – a standard practice by many large retail brokers and our guest, Adam Inzirillo, pointed out that there is a great deal of transparency around this practice as the public can see not just the amount per share, but the total dollar amounts paid to retail brokers, along with other detailed statistics. There was agreement as to the value provided by wholesale market makers given they trade as principal (and warehouse the risk associated with those trades), execute within the spread and provide a level of EQ that customers wouldn’t get in other market centers.

As the discussion turned to the competitive landscape for market centers, Inzirillo pointed out that the exchanges can face significant hurdles when trying to innovate, highlighting a recent retail order type that took 100+ days to ultimately get approval and how their CMC facility for MOCs that took three years to get approved.  For reasons like this, the feeling from Inzirillo was that the time has come for change to more easily allow exchanges to innovate and do so in a way that allows them a quicker time to market and more easily compete with off-exchange market centers.

References were also made to Canadian and European markets having different regulatory standards pertaining to exchanges and their ability to operate non-displayed market centers. In Canada, you can own and operate an off-exchange vehicle and an on-exchange market center.  In Europe, you can own and operate a lit book and a dark book.  However, the U.S. market has much greater restrictions. For example, exchanges cannot own and operate an ATS. The U.S. market, it was argued, needs to give the opportunity for exchanges to become more competitive, ultimately granting investors choice on where and how they are able to route order flow.


Issues with the SEC’s Market Data Infrastructure Proposal (aka “Reg NMS II”)

The SEC published two releases of Reg NMS II in January of this year, but would these proposals create more transparency in the U.S. equity market? Probably not. But, after all the talk 5-6 years ago about too many order types and complexity in the market, what this proposal might create is more of the same; additional layers of complexity and even more conflicts of interest.

Schwab highlighted the overarching goals of the proposals, which would:

  • Create Multiple SIPs
  • Eliminate the Unified NBBO
  • Expand “Core Data”
  • Create “Round Lots” of Fewer Than 100 Shares
  • Require Order Display Without Protection

In the midst of discussing the five proposals above, Inzirillo pointed out that, on the bright side, the SEC approved an order in early May around NMS governance, which enabled a more representative voice in the industry with sweeping changes in the voting structure:

  • Exchanges would have 2/3 of the vote
  • Non-SRO members would have 1/3 of the vote
  • Inactive exchanges no longer get a vote
  • Exchange groups w/ more than 15% market share would have two votes

Pivoting back to the main tenets of Reg NMS II, some inherent issues with the proposal that were discussed include:

  • Expanding the core data to five levels might be too intrusive with too much onus on brokers on how they route and interpret the data
  • Lack of efficiency around distribution of the SIP data
  • Creation of a PBBO and an NBBO; a two-tiered market that has a protected bid and offer and an effective NBBO is problematic, creating ambiguity and unnecessary regulatory burden
  • The need for more content on the SIP Changes in technology to ensure greater dissemination of the data as soon as info is received
  • Too many steps to staying ISO compliant – unnecessarily complex and ultimately unproductive for the industry


Predictions for the Future of Reg NMS II

In order for the proposal to survive, Inzirillo suggests the following changes:

  1. Fix the geographical latency issue with the existing providers using a distributed SIP model which grants equal access
  2. Obtain content without adding complexity
  3. Get rid of two-tiered markets – PBBO and NBBO
  4. Stay consistent with other market centers by focusing on innovation that benefits all investors

In the end, it remains to be seen how the Reg NMS II proposal will pan out, but based on a number of comment letters from industry leaders, the shared feeling was that there’s a good chance it will not get approved in its current form.



Eventus Systems is a leading global provider of multi-asset class trade surveillance and market risk solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets. Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, brokerages, futures commission merchants (FCMs), clearing firms, trading firms, market centers, buy-side institutions and corporates. The company’s rapidly growing client base of more than 60 firms relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com