By Mark S. Nelson, J.D.
The SEC’s Equity Market Structure Advisory Committee previewed its recommendations on a variety of topics ahead of its public meeting on April 26. An EMSAC subcommittee’s draft recommendation on studying the maker-taker model urged a pilot program, but possibly without some features that could impact the study of rebates, inverted venues, and trade-at provisions. The SEC has announced the agenda for the EMSAC meeting.
The various EMSAC subcommittee memos arrive as the Commission works on several market structure initiatives and as Congress eyes U.S. equity markets. Next week’s EMSAC meeting also will deal with market volatility issues addressed in a new Commission order extending the National Market System Plan to Address Extraordinary Market Volatility (LU/LD plan) to April 21, 2017 while also approving a modification of the definition of “opening price” (Release No. 34-77679, April 21, 2016).
Maker-taker pilot. The EMSAC’s Regulation NMS Subcommittee memorandum noted the controversy that infuses discussions of the maker-taker model and reform of the access fees that are now capped by Regulation NMS Rule 610. But the subcommittee also acknowledged several problems with constructing a valid method to study the impact of access fee caps under current rules. For example, the EMSAC said a pilot that is focused on a single market has limited value in showing the potential impact of access fee reforms on the wider market. The subcommittee pointed to a recent Nasdaq pilot that produced inconclusive results.
Instead, the NMS Subcommittee proposed a pilot that would be comprised of four buckets: a control bucket plus three others with graduated access fee caps, including one bucket designed to produce de minimis economic incentives. But the subcommittee noted disagreement over whether to bar rebates and whether to apply the access fee cap to inverted venues.
But the NMS Subcommittee recommended against including a trade-at provision in the pilot, as some industry participants had urged. The subcommittee memorandum explained that the presence of a trade-at provision could shift the focus of the pilot to other market issues and it would make the pilot too complex. The Securities Industry and Financial Markets Association, while broadly supporting the EMSAC’s overall efforts, also said in a statement that an access fee pilot should not include a trade-at provision.
The maker-taker model was one of the five areas SEC Chair Mary Jo White identified for further review in her 2014 speech outlining her principles for market structure reform. In recent Congressional testimony, Stephen Luparello, Director of the SEC’s Division of Trading and Markets, noted that staff in his division had prepared a briefing paper on the history of the maker-taker model that also may help to inform the EMSAC’s pilot recommendation.
Limit up/limit down order. The Division of Trading and Markets invoked its delegated authority to extend the LU/LD plan pilot until April 21, 2017. But the order also granted the participant exchanges’ request to modify the definition of “opening price,” the first reference price of the day, to mean the prior day’s closing price (or the last price reported by the securities information processor if no closing price exists) rather than the midpoint of the relevant quotations. The participants conducted back-testing that showed how the new definition could avoid many trading pauses.
EMSAC’s Market Quality subcommittee also will examine the LU/LD plan and has issued some preliminary recommendations based on its conclusion that the LU/LD bands work, but the reopening process still has too many pitfalls. First, a stock that is “stuck” in the LU/LD should automatically re-adjust after a period of time without its trading being halted. On a related note, the time during which a stock remains in the limit state condition should be extended from 15 to 30 seconds to allow markets to re-assess the stock prior to band re-adjustment.
A second proposal would have exchanges’ clearly erroneous rules conform to the LU/LD bands. Yet another proposal would invoke the concept of mean reversion to clarify that the LU band should not be triggered for a stock that trades up after having reset or halted because it had traded down to its LD band. As an example, the subcommittee memo suggested a $100 stock that traded down to $90 would not trigger the LU band when it trades back to $100, one dollar above the new $99 LU band trigger.
The EMSAC’s Trading Venues Regulation Subcommittee also published its recommendations on increasing rule-based exchange liability levels. Members of the EMSAC’s Customer Issues Subcommittee also plan to provide a status report at next week’s meeting.
The release is No. 34-77679.