It was the best of times for the trading industry. Now it’s the worst of times. Just a few years ago, the trading industry, celebrating its victories in reducing Section 31 fees and ending the uptick rule, seemed on a regulatory roll. Regulators and lawmakers appeared to listen respectfully to the industry’s view of markets.
But that has dramatically changed.
Now it is criticized by numerous lawmakers. It is despised by some of the mainstream media. Dramatic market structure changes could potentially put some firms out of business. So the industry must now play defense.
"Today, the regulatory process has been politicized, and our membership is now vulnerable to the knee-jerk reactions of Congress that are, by nature, more reliant on popular appeal than on a thoughtful analysis of empirical data," said Chuck Padala, president of the Security Traders Association of New York, which is gathering for its 74th annual conference.
In any year, prospective new trading rules are a big issue for STANY, the Security Traders Association’s largest chapter. But in this year’s environment, with the memory of the 2008 market meltdown still fresh, things are very different, STANY officials claim.
Regulators and lawmakers are in a lean and hungry mood as they look at the securities industry. Indeed, trading executives believe potential new rules–affecting everything from sponsored access to dark pools to an onerous new tax on transactions–have a good chance of passage in a new, hostile climate for the trading industry.
They point to the recent decision for an alternative uptick rule. The old uptick rule was set up to prevent trading abuses in the bear market of 1929 to 1932. Abolishing that Great Depression trading rule in 2007 was an issue the trading industry worked on for years.
But it was quickly reinstated in a whirlwind of public demand after the market meltdown of 2008. John Giesea, president and CEO of STA, fears radical market structure changes could be coming soon from the Securities and Exchange Commission and Congress.
"Great care should be taken with market structure changes," he warned.
Padala said that well-intended market-stress-standard tests and new rules governing sponsored access could drive up the costs of his members. This could be very difficult for an industry that has already lost thousands of jobs, trading executives say.
What should the industry do?
"The best thing we can do is continue to educate our representatives and make them understand that a transaction tax would cripple our industry by dramatically reducing trading volumes, thus leading to more job losses," Padala said. But so far, he admits, many lawmakers have dismissed these arguments.
So Padala and others in the securities industry must play defense. Industry critics in and out of Congress have a list of various regulatory and legislative proposals that the trading industry fears would cripple its ability to deliver liquidity to both individual and institutional clients. The misperception on the part of the public, combined with the exploitation of this misunderstanding by some politicians, has changed how the industry functions, STANY officials say.
Padala said that, in the past, the SEC regulated the markets with an analytical approach. It had "a firm belief that competition leads to more efficient markets. While not every rule pleased every member, we all understood the process by which we were governed," he said.
A sales trader with MKM Partners who has more than 20 years in the business, Padala says proposed rule changes illustrate the unprecedented hostility the industry faces. Asked how this happened, he repeatedly told Traders Magazine that "the Obama administration is against the trading industry."
E-mails to the White House press office weren’t returned at presstime.
So regulatory issues, along with threatened new laws, have taken on new significance for trading executives. Padala said that today, no one in the trading business understands the basis on which new rules are proposed other than for political gain.
Therefore, he said, lawmakers are encouraged to propose new taxes as a way of penalizing Wall Street for the nation’s economic woes, and they are also pressuring regulators to follow their lead. It is a time in which lawmakers are trying to take advantage of the security industry’s current unpopularity by adding a new securities transaction tax (STT), something that has been proposed in the past but for different reasons than the current plan. Industry observers have noted that today’s rationale for taxing the trading business would be unprecedented. This would be the first time an STT has been proposed for purposes other than regulatory costs.
If members of Congress could start taxing the trading industry to pay for jobs programs and deficit reduction, industry observers say, there might be no limit to how high a STT could go. Padala said this is a danger, but he added that there are other instances of this regulatory and legislative opposition to the trading industry. Dark pools are another example of this climate, Padala said.
STANY officials fear that regulators, under public pressure and misunderstanding the nature of the business, will curtail the use of dark liquidity. The regulators will possibly stop some venues from offering dark liquidity services. That recently concerned STANY officials. In a recent letter providing comment on an SEC release on the regulation of non-public trading interest, they argued that some members of the public don’t understand how dark pools can protect the individual investor.
"Contrary to the public perception," STANY recently wrote the SEC, "rather than serving as venues for illicit, mysterious or nefarious trading activity, dark pools offer market participants alternative sources of liquidity and choices of execution venues."
The Feb. 17 letter from STANY executive director Kimberly Unger to the SEC argued that alterative-off-exchange-liquidity is "accessed by broker-dealers on behalf of retail customers and institutions on behalf of retail institutions, as well as by traders with proprietary interests."
Another cause celebre for the trading industry is the SEC’s proposal on increased risk management controls for brokers or dealers with market access. STANY officials believe the plan goes too far. They have objected, arguing that it not only applies to naked access or even sponsored access, but to all market access.
"We do not know what the impact on liquidity might be if automatic pre-trade risk controls are applied on a per-order basis," Padala said. "We understand that systemic risk is an issue, but most firms already have pre-trade risk management in place, and the proposal in its current form would include some duplicate checks that will only increase trading costs without increased benefits."
STANY officials argue that, whether the issue is a tax or dark pools, regulators and lawmakers are proposing unprecedented rules that will dramatically change the nature of the trading business.
On dark pools, STANY officials recently conceded that the SEC for years has sought to promote public display of orders. But in the Feb. 17 letter, STANY wrote that "it has, with the exercise of sound judgment, never sought to prohibit trading venues from offering dark liquidity services to investors."
STANY suggested that perhaps the regulators aren’t interested in dark liquidity but "gray" liquidity. The latter it defined as "liquidity that purports to be dark but which is actually lit to some, but not all market participants."
Padala said the centerpiece of this hostility toward the trading industry policy has been the proposed 0.25 percent securities transaction tax. Of all the objectionable proposals mentioned, Padala said, this is the one that could do the most damage.
"I am most concerned about the punitive nature of the legislation and that its authors still view us, the traders, as the enemy," Padala said. "If Congress wants to encourage investment and capital formation, then making trading more costly is not the way to go."
Padala, along with other STANY and STA officials, cautioned that the STT is still a possibility, although some Congressional observers have said it is not likely to pass this year. "I sure hope the transaction tax is dead, but it concerns me that it has lingered as long as it has," Padala said. Indeed, an STA lobbyist, who didn’t want to be quoted by name, said the tax still has a chance to clear Congress this year in some form.
"The danger of the STT is still a real possibility. This kind of tax could be dropped in almost any bill as a revenue measure, and it could be dropped from 0.25 percent to maybe 0.10 percent. We cannot assume this is dead for the session," the lobbyist said.
Spokesmen for Rep. Peter DeFazio, D-Ore., and Sen. Tom Harkin, D-Iowa, the respective sponsors of STT plans in the House and the Senate, insisted that the idea is in play. "Senator Harkin still believes in this," a spokeswoman said. She added his bill is in the Senate Finance Committee. The spokeswoman said the lawmakers are still "fully committed" to the concept. They argue that their plans can reduce the deficit and help create programs for the unemployed.
"We cannot wait for the next bubble to pull us out of a recession. We must invest in the future, our infrastructure and our middle class," said DeFazio in a public statement, which is entitled "Let Wall Street Pay for the Restoration of Main Street."
DeFazio’s bill, HR 4191, is in the House Ways and Means Committee. Two committee spokesmen at presstime said the measures are pending and no hearings were slated on either STT measure.
Any STT measure, no matter in what form or amount it passes, would hurt more than the trading industry, Padala warned.
"A transaction tax will make trading more costly, and that ultimately increases costs for the individual investor," Padala said. Transaction volume, he predicts, would take a big hit. And that, he said, would put some firms "out of business."
