After delays are cleared, new rules will lead to big changes

The new year is expected to be an uncertain one for regulations in trading because of delays in European market rules and a U.S. pilot on tick sizes, as well as a proposal to increase transparency in dark-pool trading.

But make no mistake, said Kevin Cronin, director, global head of trading, at Invesco Ltd., Atlanta. Once the delays are gone and proposals become regulations, there will be big changes affecting institutional trading, both in 2016 and beyond. “There are a lot of things that, if they go into effect, could change the landscape of trading — in equities, but also in fixed income, derivatives,” Mr. Cronin said. “It could be a very impactful year.”

The consensus among industry participants and observers is that the dominant regulatory themes for 2016 will revolve around:

nProposed changes to the Securities and Exchange Commission's Regulation ATS;

nThe delayed start of the SEC's tick-size pilot program;

nThe delay in implementing the Markets in Financial Instruments Directive II; and

nThe possible analysis of fill orders by the Financial Industry Regulatory Authority Inc.

The SEC's proposal on changing Regulation ATS would require dark pools and other alternative trading systems to file detailed disclosures about their operations as well as the activities of their broker-dealer operators and affiliates. The proposal was announced Nov. 18 and is currently in a comment period expected to end in February. While it appears to address institutional investor concerns about information leakage on block trading in dark pools, Adam Sussman, head of market structure and liquidity partnerships at dark-pool operator Liquidnet Inc., New York, said it goes far beyond mere disclosure.

“When you dig into the SEC's proposal, they're creating new classes of trading venues,” Mr. Sussman said. “They're separating them into equity ATS, corporate bonds, over the counter, Treasuries. They're beginning to stratify the trading venues, but they'll also have different levels of disclosure. It's an entirely new regime in how they're categorized and regulated, specifically with Treasuries. In the original Reg ATS, Treasuries were specifically excluded. ... We have an asset at the heart of the American economy. The fact that it's the least-regulated security doesn't make much sense to me.”

On the equity side, most alternative trading systems have geared up for required trading disclosure, Mr. Sussman said. “But it's a new process to go through, with a review process where the SEC deems whether their filings are effective or not. Before, ATS told the SEC what they were doing and the SEC kept it under wraps. They didn't require explicit approval, and they didn't have any formal way to deny the filing. They could ask questions about the filing but not reject it. This new proposal would have a process put in place to have ATS turned down.”

Mr. Sussman said potential regulatory changes “will look at how the exchanges file with the SEC and apply some of that to ATS.”

Such moves highlight what Joseph Ratterman, chairman of Kansas City, Mo.-based BATS Global Markets Inc. and a member of the SEC Equity Market Structure Advisory Committee, said is a “shrinking difference” between lit and dark venues. “If the burden of filing for an ATS approaches that of an exchange, why have two different paradigms?” Mr. Ratterman asked. “It's inching that way, which I think is healthy. But that is a long-term issue.

“In 2016, the issue will be more clarity and uniformity in how an ATS is described: How do you operate? How do you execute?” he said. “They're simple-sounding questions, but we'll need to see how detailed this will get, how specific, how burdensome it will be for ATSto operate. If (the SEC) goes too far, you may lose the difference between an ATS and an exchange.”

While the SEC awaits comment on Regulation ATS changes, it will move ahead with its previously announced plan for a two-year pilot program to increase the tick sizes — minimum quoting and trading increments — for smaller-cap stocks. However, the start of the program has been delayed until Oct. 6, 2016, from the original start date of May 6.

The program will include stocks of companies with $3 billion or less in market capitalization, an average daily trading volume of 1 million shares or less, and a volume-weighted average price of at least $2 for every trading day.

Mr. Ratterman said most of the insights from the pilot program won't be gleaned until 2017, “but it will take a lot of work on the Street to prepare for the test, especially the trade-through portion. That will be the most painful part.”

Robert Dannhauser, head of global capital markets policy, CFA Institute, New York, agreed that while the tick-size pilot program will be “consequential to the buy side because it's a live experiment,” he said the CFA Institute doesn't think there'll be any immediate actionable information in 2016.

Across the Atlantic, the delay until 2017 by the European Securities and Markets Authority in implementing MiFID II, which expands on securities trading rules imposed through MiFID I in 2007 that focused on equity markets, has led to “a huge sigh of relief from that side of the ocean,” Mr. Dannhauser said.

“A major component is its increased requirement to measure and report best execution and the unbundling of research from brokerage,” Mr. Dannhauser said. “Brokers will need to work with investors to help determine how to characterize, measure and report what best execution is. They're European regulations, but it's hard to imagine global investors not applying this to all their investments. ... Still, many investors are split on whether to adopt these rules as global best practice vs. having two different compliance rules. MiFID II rules will mean such a dramatic change, and it would be costly to apply that to global best practice vs. the money they've already invested in maintaining the status quo.”

Constantinos Antoniades, New York-based head of fixed income at Liquidnet, called MiFID II “a moving target. The two key questions are: When will it be implemented and how will its provisions looks compared to the original guidance? Most likely, yes it will, with no huge dilution of the original (MiFID II) proposal.”

But David Weisberger, managing director responsible for trading analytics at Markit Group Ltd., New York, thinks that despite the delay, MiFID II's impact will be felt in 2016 as “the acceleration of a trend in Europe to articulate that a best-execution policy is a buy-side responsibility. It is a major change to the approach that many buy-side firms take with respect to trading. Even though it might not take effect until 2017, once it does go live, it will be too late to adapt to it. Buy-side firms should be thinking of this now; they'd be crazy not to. And, pension funds should want their buy-side firms to have a best-execution policy in place, and they should know that they have one.”

One potential issue that's been under the radar is FINRA's review of fill analysis that Eugene A. Noser Jr., co-founder of Abel/ Noser Corp., a New York-based agency broker for asset owners, said he expects to see next year.

“There will be more reviewing by regulators, particularly FINRA, in fill analysis to determine what kind of fills you're getting (on trades),” Mr. Noser said. “They'll want to look at each 100 shares executed and are they in line with best execution.”

Mr. Noser said this is an issue for the buy side because of the fragmented nature of the equity markets resulting from Regulation NMS, which he said “was written by regulators and accountants and not by those who are designing trading systems that run at very high speed.”