Compliance in Focus is a content series on regulatory topics for financial markets and the challenges compliance officers face in addressing surveillance and monitoring. Compliance in Focus is produced in collaboration with Eventus.
The U.S. Securities and Exchange Commission’s equity market structure proposals changes were assessed April 26 at the Options Industry Conference in Nashville.
Market Structure: Change on the Horizon panelists noted that regulators historically have been amenable to transporting equity rules over to the options market, so the equity proposals currently on the table are important for their potential direct implications for options trade handlers and market operators.
One SEC proposal would amend minimum pricing increments, or tick sizes, for stocks; another would require that certain retail orders be exposed to competition in newly created auctions mechanisms; another would update disclosure required around Rule 605; and there’s also an SEC best execution proposal.
“Particularly the order competition and minimum pricing increment proposals will not only obviously impact trading practices, but they also may provide new or different opportunities for bad actors to potentially influence the market,” Chris Montagnino, Director of Regulatory Affairs at Eventus, said in introducing the OIC panel. “Additional monitoring will be required to properly surveil certain market activity with a new auction mechanism in place, as well as adjustments to existing alerting if new pricing increments are permitted.”
Panelists agreed that the order competition proposal has the most opposition in the industry, followed by best execution, and then the comparatively less controversial tick sizes, and Rule 605 update.
Meaghan Dugan, Head of Options, NYSE, said the order competition and best execution proposals are the most difficult to understand the SEC’s premise for. Also, she noted that the four proposals are all interconnected and their impact needs to be considered holistically.
Rather than push ahead with the four proposals, Dugan said it would be better to “walk before you run” and move forward with some iteration of the tick size and 605 update proposals, while pausing on order competition and best execution.
A Rule 605 update is long overdue, and it will result in improved data quality for market participants, according to Mark Davies, Co-Founder and Chief Executive Officer of S3. To that end, most comment letters support the proposal.
But Davies said the tick size proposal is overly prescriptive, and as to the order competition proposal, “the SEC shouldn’t be in the business of running auctions.”
Gregg Berman, Managing Director, Market Analytics and Regulatory Structure at Citadel Securities, noted that the order competition proposal calls for auctions that would not have a broker backstop, which is unprecedented. “Nobody is responsible for the order,” Berman said. “The order only gets filled if competition and people come in.”
Panelists noted that SEC Commissioner Caroline Crenshaw recently indicated an interest in applying some of the equity market structure proposals to the options market. Specifically with regard to order competition, Crenshaw said the broker-backstopped price improvement auctions that now exist in options “operate without some of the features and protections of the proposed auctions for equity securities…(options auctions) are less competitive than they may appear to be, and certainly not as competitive as they should be.”
OIC panelists said the SEC hasn’t properly considered what impact its equity proposals would have on options markets, for example how changing tick sizes might balloon the universe of options quotes to an unmanageable size.
Dugan of NYSE said the SEC must consider that the options market is very healthy as is. “We should always help to modernize markets and provide more transparency where we should, but we don’t want to back away from markets,” she said. “We have to be careful in how we modernize markets.”
Martina Rejsjo, Director of Regulatory Affairs at Eventus, spoke with Markets Media after the OIC panel. “Given that it’s such a big reform, market participants are looking for more research, analysis, and data around the impact,” she said. “A potential outcome, after the commission has reviewed the comment letters, would be that there are some iterations to the proposals and more time will be given to the industry to assess and make changes in systems and functionality.”
