The long-simmering concerns of institutional investors and other market participants about the power of exchanges are finding an increasingly receptive audience in Washington, with regulators preparing to take a closer look.
Investor concerns range from rising exchange access fees and perceived disparities in the dissemination of market data and connectivity to the need for more transparency and disclosure in general.
Their voices have been joined by infrequent allies such as the Securities Industry and Financial Markets Association, the Managed Funds Association and the Alternative Investment Management Association. In August, the MFA and AIMA petitioned the SEC to take steps to curb the exchanges' power to charge "unreasonable fees for market data products" that wind up harming competition.
It also is a bipartisan issue at the Securities and Exchange Commission, according to Commissioner Robert Jackson Jr. In a recent speech, he blamed regulators for "standing on the sidelines" as exchanges morphed into private corporations from non-profit organizations and consolidated their power. Twelve of 13 public stock exchanges are now owned by three corporations.
"It's been something that the markets have been talking about for some time, and that buy and sell (sides) feel the same about. It's nice to see it start to get some attention," said Nat Evarts, managing director of State Street Global Advisors and its Americas trading desk in Boston. "It's not that the system works incorrectly; it's that it could be improved," Mr. Evarts said.
Proposed pilot welcomed
Many hopes are riding on a proposed SEC transaction-fee pilot program that would subject stock exchange transaction fee pricing — including "maker-taker" fee-and-rebate pricing models — to new, temporary pricing restrictions across three test groups and one control group with no cap on rebates. It also would require exchanges to prepare and publicly post data. The Canadian Securities Administrators is working on a similar program.
The pilot is strongly endorsed by asset managers including BlackRock (BLK) Inc. (BLK), Fidelity Investments, State Street Global Advisors and Vanguard Group Inc. and many U.S. and Canadian public pension funds that hope the program will give regulators critical data for assessing how transaction-based fees and rebates affect execution quality and market quality in general.
A 2017 survey of asset management firm traders by financial consultant Greenwich Associates found 65% see the maker-taker system as creating conflicts of interest that hurt the market.
Less happy with the pilot are exchanges, including Nasdaq and Cboe Global Markets Inc., whose comment letters threatened that the pilot as proposed might represent government price controls that could be challenged in court. The Intercontinental Exchange, owner of the New York Stock Exchange, in its comment letter predicted investor costs could increase $1 billion or more each year, if investors move to less-regulated off-exchange venues that are not covered in the pilot, and broker-dealers could widen spreads if exchange rebates are lowered as access fees fall. Another risk is that the pilot would create winners and losers, an exchange spokeswoman said.
'Something needs to be done'
While there might not be agreement on the pilot's final design, let alone the outcome, Brett Redfearn, the SEC's trading and markets director, said in an April speech that "it is one of the few areas where there is significant consensus among market participants that something needs to be done."
Investors are also encouraged because of a just-announced Oct. 25-26 roundtable discussion by Mr. Redfearn's division on market data and market access. "The number of voices the commission is inviting to the conversation is the right approach. We want to ensure that alignment to the investor experience is what is driving that concern," Mr. Evarts of SSGA said.
Another promising sign for investors is the SEC's rejection in recent months of two fee changes for consolidated data sold jointly by the exchanges, and suspension of connectivity fee hikes by three options exchanges. The SEC's Mr. Jackson sees those actions as a welcome change from what he considers a pattern of rubber-stamping requests from exchanges.
An August 2017 decision by the U.S. Circuit Court of Appeals for the District of Columbia also could potentially slow approvals of those requests. Instead of relying on the exchanges' arguments, the SEC has an obligation to do its own analysis, the court said.
"For now, the most important issue is that the SEC needs to issue a moratorium on fee applications," said J.W. Verret, a securities law professor at the George Mason University Antonin Scalia Law School in Arlington, Va. The free-market advocate became frustrated with the current market structure as he watched lower-cost provider IEX Group overcome opposition from Nasdaq and NYSE Group to win SEC approval in 2016 to transform from a private trading venue into a public stock exchange.
A fuller diagnosis of the problems will have to wait for the pilot results. "Before we can do anything, we need more data," said Mr. Verret.
The SEC's Mr. Jackson is also pressing fellow commissioners to address other exchange practices, including raising or removing legal limits on exchange liability when investors are harmed, the ability of exchanges to run a public data feed while simultaneously selling private data feeds, and potential conflicts of interest from self-regulation.
Congress would have to address the conflict-of-interest issue, but the SEC could make other changes, industry sources say. SEC officials could direct the SROs to include buy side and sell side market participants in their governance process and revisit low liability caps; both are moves supported by the Council of Institutional Investors and others.
Kenneth E. Bentsen Jr., SIFMA president and CEO, supports Mr. Jackson's recommendations on market data, legal liability, regulatory immunity for commercial activities and the role of exchanges as self-regulatory organizations, which his group has sought for years. "The concerns Commissioner Jackson raises are critical for the industry," he said.
Mike Williams, executive director of the Equity Market Association representing the NYSE and Nasdaq, countered that U.S. exchanges "are the most heavily regulated, transparent and trusted participants" in equity trading today, providing "more valuable, efficient and resilient trading and data services, at the lowest relative cost to investors, than at any time in history."
Circling the wagons
John Ramsay, a former SEC trading and markets chief who now is chief market policy officer at IEX Group, said large exchange operators are going into "full wagon-circling mode." Exchanges are entitled to charge for their products and services and profit from them if there is an open, competitive marketplace, but forcing market participants to connect to multiple exchanges before doing other transactions "strongly validates the chorus of complaints by brokers, traders and investors that they are being unfairly squeezed," he said.
"The commissioners, SIFMA, even members of Congress have all been grumbling for years," said Tyler Gellasch, executive director of Healthy Markets, an investor-oriented non-profit organization in Washington. "What we have that's different now is that the issues have gotten worse; prices have gone through the roof and the impact is starting to be felt by investors of all sizes. We do seem to have bipartisan consensus that these problems need to be addressed. That's a big step. We have a real opportunity," Mr. Gellasch said.
Despite seeing more movement by the SEC in the past six months than in the past 10 years, Mr. Gellasch is realistic about the exchanges' influence in Washington and on Wall Street. "We are in the second inning of a nine-inning game," he said.