The Cruel Irony of Stock Market Competition

The past 20 years has seen the erosion of the "stock exchange" as the nucleus of trading information.  Technological advancements paved the way for what would develop into electronic communication networks (blessed by the SEC in 1998 via adoption of Regulation ATS).  A confluence of forces pushed for an end to NYSE Rule 390 (which had largely prohibited member trading in NYSE listings on other exchanges); the limitation was formally rescinded in 2000.  In 2005, the SEC passed Regulation NMS, furthering the desire of the 1975 Congress for cross-market trading. 

With the push for exchanges permitting/facilitating trading at their rivals came a concomitant emphasis on each exchange enhancing its own audit trail in a manner most meaningfully capturing its order flow.  Now, as the SEC and others strain to piece together the market swoon of May 6th, consolidated trading records is the popular remedy.  But such a concentration of previously dispersed data poses many collateral questions, chief among which are the following:

• Who would own the consolidated audit trail, both in terms of responsibility for its creation and profits from the sale of its daily numbers?  

• How are the triggers for circuit breakers to be set when such brakes presently vary among exchanges?

• Will exemptions for internalized customer orders (fulfilled by firms against their proprietary holdings) and alternative trading systems render meaningless a consolidated trail (which obligates only exchanges and trading associations) ?  

• How does this all effect the anonymity that firms enjoy by placing their large trades in lesser publicized market centers?

Perhaps the mandating of cross-exchange stock histories - and the likely resulting ease in trading reconstruction - is truly inevitable.  But many other painful (and costly) decisions will have to be made, both by the chief market players and their regulators.  And the price of any rushed solution may be the progress achieved for the consumer in recent times, as exchanges unable to meet new records requirements become less viable options for traders.

In sum, any inartfully imposed consolidation of data may further set markets apart.  Thus, this fix may not be as simple as its immediate predecessor (i.e., banning universally- disdained flash trading).  A summary of the consolidated audit trail proposed last week by the SEC is available at http://www.sec.gov/news/press/2010/2010-86.htm.

---JSC, 5/31/10