SEC puts out new rules on high-frequency trading

The Securities and Exchange Commission has decided to take on high frequency trading, introducing a set of new rules for the industry. The move is an effort to oversee a previously unregulated market.

Scott Patterson had this story for The Wall Street Journal:

Securities and Exchange Commission Chairman Mary Jo White unveiled a sweeping set of initiatives on Thursday to address mounting concerns about the impact of computer-driven trading on the stock market, including proposals that would extend oversight of high-frequency traders and dark pools.

Among the most significant rules unveiled by Ms. White, in a speech to market, bank and exchange officials in Manhattan, was one that would require high-frequency traders to register with regulators as broker dealers, pulling them further under government scrutiny. Such traders have largely avoided direct oversight since they are typically private outfits trading on behalf of their owners.

Ms. White also directed SEC staff to develop a new anti-disruptive trading rule to prevent rapid-fire traders from engaging in short-term strategies that can aggravate market volatility.

Writing for the Financial Times, Gina Chon, Kara Scannell and Nicole Bullock said the SEC was likely trying to strike a balance between implementing measures quickly and taking a cautious approach to keep what is working:

Many of Ms White’s recommendations are measures that can be implemented in the shorter term and are therefore less sweeping, which could spark criticisms that the SEC is not doing enough.

But she also suggested wider-reaching initiatives that could have a bigger impact in the longer term, including examining whether SEC rules have contributed to fragmentation of the markets, such as provisions of Regulation NMS.

Reg NMS, as it is known in the industry, was adopted by the SEC in 2005 and requires that investors be able to obtain the best possible price on stock trades. But it has been blamed for complicating the markets by spurring fragmentation, with 13 exchanges and about 50 so-called dark pools, in which trading takes place outside the exchanges.

Republican commissioner Michael Piwowar commended Ms White for her initiative but said “the devil is in the details”, adding that her proposals required further study. For the market structure review to be truly comprehensive, he said, all of Reg NMS should be re-examined, instead of just portions of it.

Some experts have criticised the SEC for moving too slowly but the agency wants its assessment to be data-driven and to make fixes to the market without harming what works. The agency is also questioning the long-term impact of the race for speed and the diminishing returns around it.

Sarah N. Lynch, John McCrank and Herbert Lash included the favorable reaction from one of the largest exchanges in their story for Reuters:

The heads of the two major U.S. stock exchanges said they were optimistic after hearing what White had to say about the direction she is taking.

Traditional exchanges have been urging reforms to tackle the increasingly opaque markets, as they have lost market share to competitors such as dark pools and brokerage internalizers, which do not publicly display their quotes.

“It was clearly not a classical lunchtime speech. It was a clear policy direction for the commission, probably for the next three to five years,” said Nasdaq OMX (NDAQ.O) Chief Executive Robert Greifeld, who was in the room as White delivered her remarks.

“I have less concerns now than I had before. Obviously the commission has to work to deliver their case, but these were words of action that she used.”

White said she has numerous proposals in the works, including an “anti-disruptive trading” rule to rein in aggressive short-term trading by high-frequency traders during vulnerable market conditions, and a plan to force more proprietary trading shops to register with regulators and open their books for inspection.

Bloomberg’s Dave Michaels wrote that a recent book by Michael Lewis has brought these types of trading firms to the forefront and that the new rules extend the reach of regulators:

The new registration requirements would apply to a subset of trading firms that aren’t registered as broker-dealers with the SEC. Rick Ketchum, chief executive officer of the Financial Industry Regulatory Authority, said last month that such unregulated firms are often responsible for manipulative or disruptive trading seen by regulators.

“There still are a lot of smaller players and by forcing these firms to register there is going to be increased oversight on what she terms destabilizing HFT,” said Sal Arnuk, co-founder of brokerage Themis Trading.

The SEC is preparing a new rule that would require more oversight by traders of their algorithms, formulas that automate the buying and selling of shares, White said. While White said she was wary of setting speed limits on traders, the SEC will consider options for minimizing the speed advantage that some proprietary traders have.

It will be interesting to see if the rule actually will change the industry or if it will push electronic trading to new levels. Technology is typically ahead of regulators, so it will remain to be seen what affect the new rules will actually have on the markets and institutional investors.