TotalMarkets: Making the case for market structure reform

Published by: Adena Friedman, President & Chief Executive Officer, Nasdaq May 2019

Two years ago, Nasdaq launched Revitalize, our blueprint to reform U.S. equities markets to better serve American investors and companies of all sizes. It is time we expand the agenda to focus on the market structure that supports trading of public companies. Market structure has a significant impact on the cost of capital and the return on equity companies and their investors rely upon to grow and expand their businesses.

We believe U.S. regulators have operated with the best of intentions, but far too often, the pace of technological change has simply outrun the regulators’ ability to respond. In recent years, this gap has only increased.

In TotalMarkets: Blueprint for a Better Tomorrow, we offer the five objectives below for regulatory market reform in our belief that nothing is more powerful than free markets with clear, consistent, and fair rules that catalyze innovation, rather than inhibit it.

The U.S. equity markets exist to serve public investors, especially “Main Street” investors and retail-facing institutions that manage pension, mutual fund, and insurance assets. In the last twenty years, markets have leveraged new technology to perform repeated functions faster and more efficiently, continually testing the limits of science and the law of diminishing marginal returns. In these markets, technology has expanded possibilities in ways and to an extent previously unimagined.

Companies like Intel, Apple, Google, and Microsoft have led the way, inspiring us all to dream of what markets can become next.

In the report, we provide a detailed review of the markets today, governed by rules of yesterday, and a proposed path forward to create the markets of tomorrow. We have come to our views after months of discussions with industry participants, including a concentrated effort to engage with institutional investors and retail brokers. We have structured our proposals, first and foremost, to increase investor engagement in the US equities markets, but while also balancing the need to manage change carefully and with the recognition that all change will have some level of unintended consequences. As a summary, our proposals recommend:

Centralize liquidity in small company stocks by giving companies the choice to trade on a market without Unlisted Trading Privileges or Regulation NMS obligations.
Permit small to medium enterprises (SMEs) the opportunity to revoke unlisted trading privileges (UTP). This would concentrate their limited liquidity on their home exchange rather than fragment it across 13 venues. Maintain off-exchange trading to continue to offer choice to investors, but create a central source of price discovery, deeper lit liquidity, and on-exchange executions. This is simply restoring these stocks to their pre-2000 status, before the Commission indiscriminately extended UTP to all Nasdaq stocks.

Simplify trading for institutional investors by eliminating the Order Protection Rule for the smallest markets and allowing those small markets to innovate and operate outside some stringent requirements of Regulation NMS.
Nasdaq believes there is a better way to maintain the benefits of the Order Protection Rule while creating a better balance between value and obligation. Nasdaq proposes to give investors some freedom to choose the small markets in which to trade by excluding the smallest markets from the Order Protection Rule. At the same time, we would unlock exchange innovation by giving the smaller markets the freedom to innovate, create differentiated market models, and compete on a more level playing field with nonexchange dark pools, all within the conventions of Best Execution and SEC Rule 605.

Modernize the minimum quoting requirements and fee regimes for the markets to better recognize different liquidity characteristics of small and large company stocks.
Today’s one-size-fits all quoting and fee regimes fits a segment of stocks, but other segments would benefit from a more flexible approach that allows markets to better encourage and reward liquidity in smaller companies and in high-priced stocks.

Change the definition of “professional” and “non-professional” users in market data agreements to be more modern and flexible for retail brokers.
For many years, market data fees have differed for various categories of users. Exchanges have argued and the Commission has accepted that it is equitable to allocate market data costs across a diverse group of users by distinguishing between them based upon their purpose and ability to pay for the data (professional versus non-professional), the value they extract from the data (displayed on a screen versus non-displayed usage by a server), and the volume of data they purchase (tiers and enterprise caps), among others. However, some of the distinctions have become arbitrary and more complex than is necessary and create undue administrative burden to manage. We should modernize the user definitions to achieve the same general goals while streamlining the administrative burden.

Create more efficiency, choice, and industry participation in the Securities Information Processors through a series of important reforms.
The SIP monopolies should be reviewed to ensure that they only include the data needed to meet regulatory mandates, which in turn must match the needs of investors. This means removing vestigial data from the SIPs, while also revisiting the outdated Vendor Display Rule. Nasdaq shares the securities industry’s view that, as a public good, the SIP should be governed by a partnership between the exchanges and the industry, with appropriate government oversight and extensive public transparency. Investors should have more freedom to choose the market data they use.

We will turn these proposals into action in the coming weeks and months. We look forward to a productive and constructive dialogue with legislators, regulators, and market participants to ensure that we bring our proposals to life in a way that preserves the best of today’s markets, while marching us successfully into the future.

Nasdaq seeks to transform our proposals into action. Over the coming months, we will call for technology-powered improvements for public investors, especially main street investors and retail-facing institutions, and for issuers of all size and type. Some will call on Congress, others the SEC, and still others will launch a dialogue with investors.

Together, we will shape the equity markets of the future.


This article first appeared on LinkedIn.