Sifma calls for modernization of Reg NMS

The Securities Industry and Financial Markets Association (Sifma) has urged the SEC to revamp a landmark set of rules designed a decade ago to improve US exchanges by promoting fairness in price execution and access to market data.

Regulation National Market System (Reg NMS), which came into effect in 2005, was intended to modernize and strengthen the regulatory structure of the US equity markets amid changing technology and diversification. It comprises four central measures (see The rules below), perhaps chief among which is the order protection rule (OPR) that requires trading centers to prevent the execution of trades at worse prices than protected quotes displayed elsewhere.

In recent years, the 523-page regulation has been criticized by observers – including some regulators – who say it has helped give rise to a fragmented marketplace and high-frequency trading, which they say disadvantages retail investors.

Reg NMS is now under review as part of the SEC’s practice of each year assessing measures it has implemented to see how they are performing. Sifma provided its input in a letter sent March 29, ahead of a meeting tomorrow of the commission’s Equity Market Structure Advisory Committee (Emsac). According to the industry group, Reg NMS has been successful in creating an automated and interlinked market that gives investors the benefits of top-of-book price protection and the assurance that they are receiving the best price available for a given size at any given time.

But the regulation has also been accompanied by a variety of unintended consequences – in particular, it has contributed to a complex and fragmented market, the industry group says. ‘This fragmentation in turn has resulted in a bifurcated market that has placed a significant focus on the speed of execution, with broker-dealers facing escalating costs for essential connectivity and data services with little competitive constraint,’ writes Theodore Lazo, Sifma managing director and associate general counsel, in the letter.

‘While Reg NMS may have achieved many of the objectives set for it in 2005 in terms of promoting a more accessible, tighter-priced and significantly more automated market, the equity markets have evolved considerably and Reg NMS is overdue for review and modernization by the commission.’

The industry group outlines a series of options to improve the functioning of the national market system. To address market fragmentation and complexity, the SEC should evaluate the OPR and consider whether modifications or exemptions are needed, potentially including a volume threshold for protected quotation status and a block exemption for orders of significant size, Lazo writes. The commission could also consider dropping the rule altogether coupled with enhanced best execution principles, he adds.

Since the adoption of Reg NMS, spreads have narrowed and commissions have decreased, making the existing cap of access fees outsized relative to ‘today’s market realities,’ Lazo says. He argues that the SEC should consider addressing this by doing one of the following:

• Reducing the access fee cap to no more than $0.0005 for all securities
• Implementing Emsac’s access fee pilot recommendation
• Eliminating rebates and linkages between passive, posting of limit orders and transaction pricing.

Lazo also suggests that, to ensure market data is timely, comprehensive, non-discriminatory and accessible to all market participants at a reasonable cost, the commission should consider:

• Enhancing the securities information processor (SIP) feeds with bid and offer quotes beyond the top-of-book data and providing that as the sole source of consolidated market data to meet regulatory obligations
• Replacing the single-consolidator SIP model of market data dissemination with a competitive construct, such as a competing market data-aggregators model.

THE RULES
Reg NMS comprises four key measures:

• The OPR requires trading centers to ‘establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers, subject to an applicable exception.’ To be protected, a quotation must be immediately and automatically accessible
• The access rule requires fair and non-discriminatory access to quotations, sets a limit on access fees to harmonize the pricing of quotations across different trading centers and requires each national securities exchange and national securities association to adopt, maintain and enforce written rules that prohibit members from engaging in a pattern or practice of displaying quotations that lock or cross automated quotations
• The sub-penny rule bars market participants from accepting, ranking or displaying orders, quotations or indications of interest in a pricing increment smaller than a penny, except for those that are priced at less than $1 per share
• Amendments to the market data rules that update the requirements for consolidating, distributing and displaying market information, as well as amendments to the joint industry plans for disseminating market information that modify the formulas for allocating plan revenues and broaden participation in plan governance.