WASHINGTON -- Industry leaders are worried that newly proposed regulations-such as the financial reforms being debated by the Senate and the Securities and Exchange Commission's large trader reporting system-would seriously hinder market activity. But officials argue that such changes are necessary to bring markets out of the dark.
"To better oversee the U.S. securities markets, the Commission must be able to readily identify large traders operating in the U.S. securities markets and obtain basic identifying information on each large trader, its accounts and its affiliates," said SEC Chairman Mary Schapiro. "In addition, to support its regulatory and enforcement activities, the Commission should have a mechanism to efficiently track and promptly obtain trading records concerning large traders."
A large trader would be defined as a firm or individual whose transactions in exchange-listed securities exceed $20 million during any calendar day or $200 million during any month. Each large trader would be assigned an identification number, which would have to be disclosed to their broker/dealer.
Blazing, Millisecond Speed
Schapiro said rapid technological advances have impacted trading strategies and the ways in which some broker/dealers carry out their trades. Regulators are struggling to keep up.
"Today, trades are transacted in milliseconds and dispersed among many trading centers," she said. "This allows large market participants to employ sophisticated trading methods to trade electronically in substantial volumes with blazing speed in multiple venues."
But industry leaders counter that these advanced trading technologies are extremely beneficial, as is the concept of keeping trading information private.
"The biggest issue with block trading is information leakage," said Mark Van Meter, head of equity trading at Victory Capital Management, speaking at the Mutual Fund Directors Forum's 10th Annual Policy Conference here on critical issues for investment company directors. "Whenever you call your broker, you're showing your hand. Information is lost every time you tell someone."
Van Meter said electronic trading allows firms or individuals to trade a large number of stocks through dark exchanges or dark pools, without telling anyone what they're doing.
Despite their sinister-sounding name, dark pools of liquidity can be very beneficial to average investors by offering mutual funds and large institutional investors an efficient way to make large trades without impacting the market.
There have always been people who try to take advantage of large orders by stepping in front of trades and messing with prices, Van Meter said, but the use of dark pools allows individuals or firms to execute large orders without giving up their name.
"Things are much more efficient than they used to be," he said. "It's all executed electronically. A computer is making all the buy/sell decisions, based on the information we input. Dark pools sound scary, but they're actually excellent tools for investors. The environment has never been better for the retail investor."
Experts now say fewer than half of all trades occur on listed exchanges, and the combination of trading algorithms and high-frequency systems makes it easy to disguise large orders by breaking them up into small pieces. Disguising large trades is critical to best execution, these experts say.
"A few years ago, the SEC decided there should be competition between exchanges, based on a central clearing facility," said Robert Colby, counsel at the international law firm Davis, Polk & Wardwell. "All these competing markets have siphoned off market share. The New York Stock Exchange now has less than 20% of the market share."
Many financial leaders worry that the exploding popularity of these private crossing networks runs contrary to mutual funds' promise of transparency.
Consolidated Audit Trail
The proposed large trader reporting system is a good step toward the goal of a much more comprehensive, consolidated audit trail, said Commissioner Luis Aguilar.
"A consolidated audit trail would provide broader insight into transactions in the markets and would provide the Commission with the ability to oversee, in real time, activity within and across securities markets," he said. "It would also allow us to track individual orders through each step in their lifecycle-from inception through modification, routing, execution and settlement."
The SEC also said that besides accumulating trading information from mutual funds, identification numbers would also be assigned to hedge funds and private equity firms.
"This information should significantly improve the Commission's ability to conduct timely and accurate trading analysis for market reconstructions and complex enforcement inquiries or investigations, as well as inspections and examinations of large traders and their activities," said Commissioner Elisse Walter.
Curb on Options
The SEC also proposed prohibitions on options exchanges from impeding access to displayed quotations, and aims to limit the fees an options exchange can charge investors. "It is important that investors have the ability to access the best prices available regardless of the exchange that is posting the quotation," Schapiro said. "Those investors should have a better understanding of the true cost of executing a transaction."
In an effort to bolster support for the reforms working their way through Congress, President Barack Obama came to New York Thursday to make his case before Wall Street.
"These reforms are designed to respect legitimate activities but prevent reckless risk taking," Obama said. "We want to ensure that financial products like standardized derivatives are traded out in the open, in the full view of businesses, investors and those charged with oversight. The only people who ought to fear the kind of oversight and transparency that we're proposing are those whose conduct will fail this scrutiny."
Obama said there has always been a tension between those who want markets to function without interference and those who insist on setting rules, but managing that tension has helped the U.S. keep up with a changing world.
"In the end, our system only works-our markets are only free-when there are basic safeguards that prevent abuse, that check excesses and that ensure that it is more profitable to play by the rules than to game the system," Obama said.
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