On December 14, 2022, the U.S. Securities and Exchange Commission made a splash when it released four proposals to revamp equity market structure.
It was a big deal. The Wednesday afternoon communiqués spoiled the plans of compliance executives, technologists and market structure analysts who had hoped for some holiday-season downtime, as the industry immediately kicked into analysis and response mode. In the following weeks and months, there were countless research reports published, comment letters written, and in-person briefings held, all to discuss the good, the bad, and everything in between about the proposals, pertaining to impacts on markets, liquidity and trading.
More than a year and a half later, one of the four proposals has been implemented, and the other three remain pending items. The industry hasn’t lost interest in the unfinished business, but the three proposals seem to have eased off the front burner as far as readiness and mobilization to-do-list items, and it’s unclear how long the chief architect of the proposals, SEC Chair Gary Gensler, will remain in his seat.
Here’s an update on where things stand.
Amendment to Rule 605
The SEC proposed updating disclosures required under Rule 605 of Regulation NMS for order executions in national market system stocks, in the first substantive update to the rule since it was adopted in 2000. Of the four equity market structure proposals, this one had the most industry support, and on March 6, 2024, the SEC adopted final rule amendments.
Tick Size / Access Fees
The SEC proposed to amend minimum pricing increments, or “ticks”, for certain NMS stocks. There has been no follow-up yet on these proposals, which would amend Rules 610 and 612.
Brett Redfearn, Founder of Panorama Financial Markets Advisory and former Director of Trading and Markets at the SEC, believes that of the three pending proposals, this is most likely to resurface.
“The most likely market structure rule we can expect this year is a scaled back version of proposed changes to tick sizes and access fees, Rules 610 and 612, also with new round lots and odd lots disseminated to the tape,” Redfearn told Traders Magazine. It is reasonable to expect that the Commission could pass this in the fall, and that it will be substantially dialed back from the initial proposal.”
The SEC has proposed new ticks at one-tenth of a cent, two-tenths of a cent, and half a cent; Redfearn said a final rule likely will only have half-cent ticks for penny-constrained stocks, though the contentious issue will likely be regulatory overreach in the definition of penny-constrained stocks.
“This approval would also include a cut to the access fee cap in Rule 610,” Redfearn said. “The big question is, will we see a 10 mil or 15 mil access fee cap?”
Jesse Forster, Senior Analyst, Market Structure & Technology at Coalition Greenwich, said the industry is amenable to trying to make something work for this proposal. “There’s solid interest in experiments or pilot programs around tick sizes and access fees,” he said. “The SEC’s aversion to pilots is well-known, but if they were willing to listen to industry input and design a proper pilot program, they’d have a lot of support.”
Best Execution
The SEC proposed Regulation Best Execution, which would enable the regulator to have its own best-ex rule alongside that of the Financial Industry Regulatory Authority (Finra). The SEC proposal highlights conflicted transactions, in which broker-dealers handle retail orders while having a potential conflict of interest.
“The best execution rule has been very controversial from the beginning,” Redfearn said. “There has been a lot of pushback on several elements of that proposal. It’s unclear how two versions of best execution should work in the world practically, where one is for conflicted orders and one for unconflicted orders.”
“Most significantly, I doubt the economic analysis that provides the underlying basis for the rule remains valid after approvals for Rule 605, 610 and 612, which completely change the baseline,” Redfearn added. “So I don’t think approval of Best Execution is a sure thing.”
Order Competition
The SEC proposal most roundly criticized by the industry is the proposed rule to enhance competition for retail trade orders. The idea is to expose certain retail trade orders to newly created auction mechanisms to provide for more competition, and at least theoretically, better execution for retail investors.
“I’ve heard chatter that the auction proposal is going nowhere,” said Jim Angel, Associate Professor at Georgetown University’s McDonough School of Business and a market structure and regulation specialist. “Perhaps Gensler & Co. actually paid attention to the buzzsaw of opposition to the plan. Even the exchanges that presumably would have benefited from the plan opposed it.”
“I think the chances of an order competition rule and retail auctions have gone from little to none,” said Forster of Coalition Greenwich. “The institutional community has lost interest in even discussing how they might operate.”
“The order competition rule is probably dead and will never see the light of day,” Redfearn said. “It wasn’t a workable proposal and was not well thought out. It was overly prescriptive and shouldn’t have been proposed as it was. I don’t think it could ever get traction without a substantially modified re-proposal.”
The Big Picture
The SEC is tasked with protecting ‘mom-and-pop’ investors, a point that Gensler has emphasized when explaining the rationale for the equity market structure proposals.
Market operators and retail trading platforms say the proposals go too far and could be counterproductive by diminishing liquidity.
“It has never been easier and cheaper for retail investors to participate in the stock market,” Matt Billings, Vice President, Brokerage & President at Robinhood Financial & Robinhood Securities, told Traders Magazine. “The SEC should approach additional market structure reforms with caution and only after carefully studying the impacts of its recent Rule 605 reforms. The data on retail investors’ access to the stock market and the execution quality they receive when they invest and trade simply does not support the aggressive reforms currently being considered by the SEC.”
As the clock ticks on the open proposals, Georgetown’s Angel noted that the SEC has been moving slowly even on smaller more routine business, such as an NMS filing to update the limit-up, limit down (LULD) bands on exchange-traded funds (ETFs).
The academic offered several theories that could explain the long lead time: Gensler may be prioritizing other rulemakings such as predictive data analytics; the Chair is possibly having trouble getting two SEC commissioners to sign on to final rules for a majority; and the SEC’s limited resources means it’s choosing to take its time to get it right, rather than rush something through.
“Market participants on all sides are eager for any kind of response from the Commission” with regard to the pending items, Forster said. “The longer these drag on, the less likely we are to see any implementation. The Chair may be running out of time between a lack of industry support and the US presidential election.”
Redfearn said “there was a disturbing lack of widespread industry engagement” before the SEC unveiled the equity market structure proposals. “That was a problem that led to more problems,” he said. “There was a desire on Chair Gensler’s part to get a lot of things done, which led to proposals that were not well-vetted.”
“We’ve witnessed a negotiation style of rulemaking where proposed rules were intentionally overly broad in scope, so that they could be modified during the comment process but still be aggressive after they’re dialed back,” Redfearn added. Also, “In my view, the proposals generally reflected an overly cozy relationship with the big stock exchanges and a failure to appreciate or understand the benefits of non-displayed liquidity.”
What’s Next
The what’s-next question for the equity market structure proposals is further muddled by the calendar that is in the slow summer season for the next couple months, and then will be in pre-election season for the following two months, in which regulatory action could be perceived as politically motivated. Then the November presidential election itself could result in Gensler leaving the commission before his term expires in 2026.
In a June 25 interview at the Bloomberg Invest conference in New York, SEC Chair Gary Gensler did not address the equity market structure proposals specifically, but he spoke generally about the SEC’s inbox.
Gensler said: “There are still some rules we have proposed and we have not yet adopted that we are working on, but we are not doing it against a clock.”
Gensler said he’d be “honored” to serve as Chair until 2026, but if he’s pushed out by a change in the White House, “then that’s democracy in action.”
He emphasized that the SEC is not working under any timeline around election day in November or inauguration day in January 2025. “We are considering public feedback on rules we have proposed but not publicly adopted, but not against a clock,” Gensler said. “You run the field as well as you can run the field, and when the ref calls the clock you see where you are.”
“I would bet the Chair bats .500” on the proposals, Redfearn concluded. “Rule 605 is done, and reductions to the minimum tick and access fees are mostly baked in. But the order competition rule is toast, and best execution may be in trouble.”
