Gary Gensler, Chairman of the U.S. Securities and Exchange Commission (SEC), at the SEC’s Washington, D.C., U.S. headquarters office on Thursday, July 22, 2021.
Melissa Lyttle | Bloomberg | Getty Images
SEC Chairman Gary Gensler is trying to deliver on his promise to address what he believes are shortcomings in the US trading system.
Each fall, the Securities and Exchange Commission publishes a “Rule List,” essentially a wish list of rule changes the agency would like to implement. Gensler’s fall 2021 list includes nearly 50 proposed rule changes, one of the largest lists in decades.
It also includes the following proposal: “The Division is considering recommending that the Commission propose rule changes to modernize rules related to the structure of the stock market, such as those related to order routing, conflicts of interest, best execution, market concentration and dissemination of the best performance statistics.”
While the SEC has been silent so far about what it is proposing, industry insiders have been quietly saying that Gensler will likely use a speech at the Piper Sandler Global Exchange & Brokerage Conference on Wednesday to present several proposals.
This can include best execution and pay for order flow.
Better execution and payment for order flow
Gensler has been critical of ordinary investors’ lack of understanding of what they are paying when they execute a trade. He wants more transparency for investors about how the trades are run and at what cost.
He has been especially critical of payment per order flow (PFOF), in which brokers send their orders to market makers in exchange for payments. This allows some brokers to charge zero commissions. Gensler said there could be a conflict of interest for brokers and that too much power is concentrated in a handful of market makers.
To break this concentration, industry participants say that Gensler may propose that retail orders be routed to an exchange, automated trading system or some other auction platform that would provide a deep pool of liquidity for retail orders, and not simply routed to a wholesaler like Virtu or Citadel, as some brokers do these days.
It is unclear whether Gensler would also propose an outright ban on payment by order flow. As exchanges like the NYSE and Nasdaq also provide payment for order flow in the form of discounts to customers who submit orders to their exchanges, any such ban would likely be contested by many parties, including the exchanges.
It will likely require more transparency about trading and payment for order flow. Gensler may propose tightening the rules that constitute best execution, which is generally the obligation to provide the best prices at the time of execution. He may want more disclosure to describe the obligations a brokerage has, including price improvement and payment for the order flow.
For example, if an investor is paying $10 for a trade, but $2 of that amount is payment for the order flow, Gensler may seek more disclosure about how the total cost of the trade is communicated to the investor.
The industry retreats
Industry insiders have urged Gensler to be careful when altering a complicated system, which they say is working very well for the retail investor.
A spokesperson for Citadel, one of the largest wholesalers participating in pay-by-order flow, released the following statement to CNBC: “It is important to recognize that the current market structure has resulted in tighter spreads, greater transparency and significantly reduced costs for the retail We look forward to reviewing the proposals and working with the SEC and the industry towards our long-standing goal of further improving competition and transparency.”
This caution was echoed by others in the US trading system.
“You have to be very deliberate about this approach,” Ken Bentsen, president and CEO of the Securities Industry and Financial Markets Association (SIFMA), told me in February.
“We’ve been asking for a review of the market structure for some time, but we’re going to be careful not to try to fix things that might not be broken,” he said. “The retail investor is getting a better deal than ever before.”
More trading on traditional ‘lit’ exchanges
Gensler has also been critical of the growth of dark pools and other off-exchange trading, which now make up around 40% of all trading volume.
To combat this, industry participants say Gensler may propose harmonizing rules governing minimum trade sizes. Exchanges generally cannot execute orders in increments of less than one cent, but off-exchange participants can. Gensler wants to level the playing field so that all trades can take place in the same increment size, in some increment smaller than a penny.
Gensler believes that if all participants in the trading system were required to trade in the same increments (say, a tenth of a cent), there would be a greater chance that discounts could be reduced from exchanges and more trading would be pushed to traditional exchanges.” lit”.
A firm rule proposal or trial balloon?
Industry participants were unsure whether Gensler was proposing a full set of market structure proposals.
“It’s unclear whether Gensler is proposing a rule change right away or just floating a ‘test balloon’ that could result in a rule proposal later in the year,” David Franasiak, a lawyer at Williams & Jensen who tracks corporate affairs in Washington , told me.
Market structure just one of many Gensler proposals
This is one of many proposed regulations that Gensler has on his agenda.
“This is one of the biggest regulatory agendas we’ve seen from the SEC in many years,” Amy Lynch, president of FrontLine Compliance and former SEC compliance officer, told me in February.
Since then, the agenda has only increased. Gensler proposed rules on managing cybersecurity risk, borrowing and borrowing securities, reporting short positions by investment managers, shortening the settlement cycle for stock trading, compensation versus performance for corporate executives, improved disclosure about specific purpose, as well as insider trading and corporate buybacks.
One of the most controversial proposals – a proposed rule on disclosing climate change risks – is now open to the public for comment until 17 June. and nominees) and human capital management (additional disclosure on how companies manage their workforce).