4. Integrity of a Marketplace

Daniel (Dan) Gallagher, SEC Commissioner, November 2011 to October 2015.

Reg NMS (Regulation National Market System) was adopted by the Securities and Exchange Commission in 2005 and introduced 2 years later to further advance the ideals of a national market system. The regulation includes the order protection, or trade-through rule, access rule (fair access) to market data including quotations, and rules on sub-penny trading and on market data.

Founder of the now defunct Arizona Stock Exchange, an electronic stock exchange, the headquarters of the company was based in New York. A former Kidder Peabody vice president, Wunsch is also known for his expertise and knowledge of market structure and for his free enterprise outlook.

Bob Pisani is a news correspondent for financial news network CNBC and covers the New York Stock Exchange from the floor.

Equity Trading in the twenty-first Century: An Update James J. Angel, Georgetown University. Lawrence E. Harris, University of Southern California. Chester S. Spat, Carnegie Mellon University (June 06, 2013, Knight Capital Group).

See 2.

Referring to a proposed pilot program for trading small-cap stocks in wider minimum increments. The pilot eventually was approved by the Securities and Exchange Commission. See SEC Approves Pilot Program to Assess Tick Size Impact for Smaller Companies. Center for Financial Stability, May 7, 2015. http://​centerforfinanci​alstability.​org/​wp/​?​p=​5987

2013 continued to see falling interest rates following the 2008 financial crisis. Consequently, falling rates had allowed the value of bonds to increase as yields declined. Bond prices move inversely to interest rates as is well known. With short-term rates in 2013 at almost zero, and long-term rates at record lows, it was practically impossible for rates to dip any further. As 2013 progressed, rates started to climb. Rising rates would ultimately translate into meager yields but also losses of principal, according to financial experts. The Dow Jones industrial average had a banner year in 2013, its best since 1998, gaining 26.5%; the NASDAQ soared 38%. Meanwhile, investors were taking flight from bonds, pulling over $70 billion from bond mutual funds, according to TrimTabs, by one measure in December 2013. See Stock: 2013 is one for the record books. Ben Rooney. CNNMoney.​com. December 31, 2013. http://​buzz.​money.​cnn.​com/​2013/​12/​31/​stocks-record-bull-market/​Stock

For a comprehensive account of dark pools and their opposite in lit markets, see Dark Pools: Fear of the Dark. Third Way. Lauren Oppenheimer, John Vahey. August 28, 2013.

http://​www.​thirdway.​org/​report/​dark-pools-fear-of-the-dark.​ The authors explain: “Dark pools are private, electronic stock trading venues that allow buyers and sellers of a stock to be matched anonymously. In a dark pool, prices are not displayed to investors—stock prices are dark. Dark trading is an alternative to trading on a ‘lit’ exchange, like the New York Stock Exchange (NYSE), where traders benefit from visible prices.”

“Pit” and “open outcry” are synonymous. Open outcry is a broader name for any exchange-based trading on a traditional exchange floor, though the term pit has an implied association with the futures and options markets in Chicago. Traditional specialists operated on the floor, and in what’s known as the upstairs market, where brokers work larger-size orders between each other. Liquidnet says its model most closely resembles block trading in the upstairs market but also differs, by expanding access from just brokers to also asset managers and related professional wholesale market participants.

2016 data supplied by Liquidnet.

Principles-based regulation is the concept of regulation that lays our broad but clearly defined principles that business is expected to follow, in contrast to rules-based regulation that defines what is right and wrong and the boundaries of the law.

A program promoted by exchanges to encourage trading on their individual exchanges. Maker-taker fees offer a transaction rebate to trading participants who provide liquidity, charging customers who take liquidity.

In a follow-up interview, Katz, for clarity, noted that he was talking about options trading and that the “fee” was charged on a per share or per contract basis.

Ibid.

See 9.

“Trade Reporting Facilities, commonly called TRFs, are venues for alternative execution facilities to report trades to the consolidated tape. ECNs and brokers, executing stock trades away from the exchanges in the US must report their trades to a TRF. Originally, all broker dealers internalized stock trades, and as well as crossing networks and ECNs that matched trades from their customers, had to report their trades to the National Association of Securities Dealers (NASD), via the NASDAQ Stock Market’s Automated Confirmation Transaction System, known as ACT.

“However, as a condition for the US Securities and Exchange Commission’s approval of NASDAQ’s application to register as a national stock exchange, and separate from its regulator, the NASD, the SEC insisted there be a separate TRF within the NASD. This opened the doors for other exchanges to create TRFs with the NASD, and to atttact trade printing income.” Source: Markets Wiki.

In a follow-up, Katz noted: “The reason that the SEC does not touch this is that stocks are issued by a company, while options are issues by the Options Clearing Corp (OCC). The OCC is owned by the exchanges, and so they would not support options being traded off exchange. If they traded off exchange, they would not be fungible with the options cleared by OCC. I believe that the SEC would want everything traded on exchange but the genie is out of the bottle in equities. They would not make that same mistake in options.”

The well-documented global financial crisis of 2007 and 2008, tied in the United States to subprime mortgage lending. As a reminder, the fall of Lehman Brothers, a global banking behemoth, in September 2008, almost brought the world’s financial system to its knees. The worse recession in 80 years followed, but it took massive amounts of fiscal stimulus in the United States to avoid a downward economic spiral, according to financial historians.

See 8.

London Interbank Offered Rate used by some large banks to calculate interest rates on various loans and also used as the benchmark rate some large global banks charge each other on loans.

The orderly liquidation provision in the Dodd-Frank law empowers regulators to seize a major financial firm that is headed for collapse and dismantle it in a way that is less disruptive than either taxpayer-funded bailouts or bankruptcy.

See FDIC Initiatives under the Dodd-Frank Wall Street Reform and Consumer Protection Act. https://​www.​fdic.​gov/​regulations/​reform/​initiatives.​html

See Insurance Liabilities Could Be Next Big Thing for Investors. Start up Extraordinary Re is bringing much-needed change to the insurance industry by securitizing underserved risks. Julie Segal, Institutional Investor. September 21, 2016. http://​www.​institutionalinv​estor.​com/​article/​3587123/​investors-endowments-and-foundations/​insurance-liabilities-could-be-next-big-thing-for-investors.​html?​ArticleId=​3587123&​p=​1#/​.​WNvnatQrLvZ

In GAPP, or Generally Accepted Accounting Principles, some income streams have to be adjusted when there are changes in their market value. There are exemptions such as certain inventories and bonds bought to be held to maturity. In an insurance company, any changes in the market value of a stock portfolio held for investment have to be factored into the income calculations of the insurance company, a process which is referred to marking the income “to market” (or “marked to market”).

Referring to the idea that the insured party, say a municipality which oversees a major public water dam, inherently knows much more about the specific risk scenarios of the insured risk, than outside parties, most notably the insurance company underwriting the risk.

Ibid.

In practical terms, as one analyst noted, the Extraordinary Re electronic platform would offer more transparency, more liquidity, and a more accurate reflection of risk and supply in this otherwise “opaque” marketplace today. Big insurers would have a benchmark for their next deal derived from information gathered over time on insurance risk factors and as shares of insurance contracts are traded on the platform.

Van Slyke is jokingly taking these two well-known Wall Street practitioners to make his point, the first practitioner held out here being a low risk, the second a high risk! (Rosen, the latter practitioner, is affiliated with Extraordinary Re.)

A reinsurance sidecar, sometimes referred to as a reinsurance sidecar vehicle or simply a sidecar, is a financial structure established to allow investors (often external or third-party) to take on the risk and benefit from the return of specific books of insurance or reinsurance business. Source: www.​Artemis.​bm

Aug. 1 stock trading fiasco costs Knight $604M, USA Today, October 17, 2012. According to the opening paragraph in this AP story: “The Knight Capital Group trading firm said it lost $764.3 million in the third quarter because of a software glitch that flooded the stock market with trades one day in August, causing dozens of stocks to fluctuate wildly.” http://​www.​usatoday.​com/​story/​money/​markets/​2012/​10/​17/​knight-capital-earnings/​1638817/​

SuperDot was the electronic system used by the New York Stock Exchange to route market and limit orders from investors, or their agents, to a specialist on the floor of the exchange. SuperDot was the upgraded and predecessor system of the Designated Order Turnaround (DOT) system. In 2009, SuperDOT was replaced by the NYSE Super Display Book system (SDBK) for processing orders. In 2012, the Display Book was replaced by the Universal Trading Platform (UTP).

“Lousy” here is referring to Pisani’s later comment that some traders are not making “much money” because market volatility was low at the time of this conference. Higher levels of volatility can drive profitability for traders.

Regulation Systems Compliance and Integrity (Regulation SCI) is a set of rules created by the US Securities and Exchange Commission to monitor the security and capabilities of US securities markets’ technological infrastructure. The Commission adopted Regulation SCI and Form SCI in November 2014. Regulation SCI replaced the SEC’s Automation Review Policy guidelines, developed in 1989 and 1991 after the 1987 market crash known as Black Monday, when the Dow Jones Industrial Average plummeted 23%.

“The Security Information Processor (SIP) links the US markets by processing and consolidating all protected bid/ask quotes and trades from every trading venue into a single, easily consumed data feed.” Source: Consolidated Tape Association.

More broadly, the NYSE and NASDAQ, at time of writing, each operated a SIP for US stock exchanges, the former showing the best bid and offer for NYSE-listed stocks, the latter showing the NBBO for NASDAQ stocks. These data processors consolidate quote and trade data for stocks listed on their exchanges. The data is then disseminated for a fee to investors, market-data providers, and others. NYSE also operated a SIP for options exchanges.

See 12.

See 33.

In a follow-up interview, Ross further defended the maker-taker model, saying it was a way to reward participants, market makers, and HFT traders, for posting bids and offer in a marketplace where spreads have narrowed with the aforementioned advent of penny trading. In the past, the spread was wide enough to allow market makers to make money. Ross uses the analogy of the common practice of tipping restaurant staff in America. “In Europe, the tip is included, so adding the tip in the US is closer to the maker taker model,” he said. What about reported abuses of the maker taker model, such as rapid-fire trading for rebates? “It occurs in any market anyway, and not because of maker taker. I think it is a confusion of symptom with the problem. And so I discount that idea very heavily,” he responded.

An OMS is an electronic platform that facilitates and manages the order execution of securities, typically through the FIX protocol. Order management systems are used on both the buy-side and the sell-side.

Referring to block trading where two naturals meet each other.

Ross explained, in a follow-up, by offering the example of 5 cents profit seemingly made on a 100-share trade by one of these same HFT guys, posting at $500.01, or a penny a share. In reality, this is not 5 cents profit, he argued; rather the profit is a fraction of a penny since the same trader may take losses on as many as half his trades and as adverse selection is subtracted in the calculation.