Chicago Board Options Exchange
Edward J. Joyce
March 19, 2001
Mr. Joel Seligman
Dear Dean Seligman:
Unfortunately, I will not be able to attend the April 12 meeting of the SEC Advisory Committee on Market Information as I have a conflicting engagement on that date. Because I will not be at the meeting, I am writing this letter to convey to you a few thoughts concerning some of the issues that were raised at the last meeting and that may be the subject of further discussion on April 12. Admittedly, most of my experience with these issues has been in the context of the listed options market, which is not currently being addressed by the Committee. Nevertheless, I am presenting my thoughts on these issues at this time because I believe they apply just as much to the use of consolidated market information in the equities markets, which is the current focus of the Committee's attention, as they do to the use of market information in the options market. The issues I will briefly address concern how best to provide consolidated market information to investors, what should be the governance model for the information consolidator, and what should be the standards for determining fees to be charged to users of consolidated market information.
In considering how to provide consolidated market information for equities, at our last meeting you presented five different possible recommendations for the Committee to consider. One of these (recommendation C in your list) involved the dissolution of existing joint SRO Plans and having each exchange and the NASD file a separate transaction reporting plan (which presumably also would cover the reporting of quotations), while retaining an exclusive consolidator of market information that would be selected through competitive bidding. I have several problems with this model, not all of which surfaced in the discussion on March 1.
I start from the point of view that the existing model for the consolidation of securities market information, while not perfect, has for the most part worked well over the more than twenty-five years that it has been in operation. During this period it has proved itself to be technically sound, with very little unplanned down-time, and sufficiently flexible to accommodate enormous changes in markets and technology that have revolutionized the ways in which securities are traded and market information is disseminated. Given the record of success of the exiting model, I am reluctant to support making sweeping changes to it that may not be needed. Thus, I am fundamentally skeptical of any approach that would involve the wholesale dissolution of the existing Plans, which I believe have served the public so well for so long. Instead, I much prefer to identify those specific problems that may exist within the existing model and then to develop specific, narrow-focused solutions for those problems.
Beyond my general opposition to any kind of revolutionary change to the existing model, I believe it would be highly impractical if not totally impossible for each exchange independently to develop its own plan for transaction and quotation reporting while at the same time continuing to provide for the efficient consolidation of this information through a single consolidator, as recommendation C seems to contemplate. For example, how could a single consolidator construct a computer system and a communications network to consolidate the separate data streams emanating from each market without a good deal of coordination among the markets in such matters as standardizing the format and specifications applicable to the data being disseminated? Likewise, wouldn't the efficient development of the computer and communications systems needed to provide a single consolidated transmission of market information require that all of the markets whose information is to be included in the consolidated transmission must agree to receive the same type of services from the consolidator over the same period of time? To the extent joint and coordinated action by the markets continues to be needed in order to be able to achieve a single, consolidated data stream encompassing all securities market information (it appears to be a fundamental assumption of Section 11A of the Exchange Act that such joint and coordinated action is required), it seems that we would have to reinvent the current Plans in any event if we begin by dissolving them.
I also do not believe it is wise to mandate competitive bidding for the selection of a single consolidator, even though there may be times when the markets on their own may decide to engage in a competitive bidding process for this purpose. In fact, in connection with the selection of their initial processor under the OPRA Plan, in 1975 the options exchanges did receive competitive bids from several vendors, and selected SIAC as processor on the basis of the strength of its bid. (The NYSE, as majority owner of SIAC, was not then trading options and had no role whatsoever in the selection of SIAC; to the contrary, to the extent SIAC's affiliation with NYSE had any impact on its being selected as OPRA's processor it probably was a negative one.) But while it is one thing to acknowledge that competitive bidding may at times be a useful tool in the selection of a consolidator, it is quite another, and would in my opinion inject unnecessary inefficiencies into the process, to mandate competitive bidding on any sort of regular or periodic basis. Changing a consolidator is not something to be done lightly, not only because of the costs and other difficulties associated with the transition from one consolidator to another, but also because of the long-term equipment leases, software licenses and other long-term arrangements that consolidators must enter into in connection with the development and operation of their sophisticated computer and communications systems. If a consolidator knows that it will be subject to competitive bidding in any time frame that is less than the duration of the long-term contractual commitments it will have made in support of its activities as consolidator, it either will have to avoid all long-term commitments or it will have to include in its price the risk that it will be subject to nonrecoverable costs in the event it is not selected to continue as consolidator in the next bidding. In either event, the cost of consolidation to the markets will be greater than if they were not bound to resubmit the consolidator's contract to competitive bidding on any fixed timetable.
Finally, even if it is possible to provide for a single consolidator of market information under the separate plans of each market, I believe a good number of efficiencies will be lost if the joint plans are dissolved. Among these are the benefits of having a single contract and centralized contract administration covering market information from multiple markets. Also lost would be operational efficiencies such as the ability to incorporate in a consolidated system such features as a "dynamic throttle" that permits a market experiencing a peak demand for message-handling capacity to "borrow" on a temporary basis excess capacity from one or more other markets. While it may be possible to provide for these kinds of administrative and operational efficiencies by means of identical provisions in separate bilateral contracts between each of the separate markets included in the system and between each of those markets and the consolidator, this would certainly be much more difficult to accomplish than the current model of a single plan to which all of the markets are subject.
Turning next to the governance systems of the existing plans, I also believe these have largely worked well over the years, and have been the occasion of surprisingly few complaints. If there is anything problematic about plan governance, it may be the special prerogatives enjoyed by the Plan Administrators under the equity plans, which have no counterpart in the OPRA Plan. Under the OPRA Plan, each exchange has one equal vote on all matters that come before the OPRA Policy Committee, with the sole exceptions that there is provision for a volume-weighted tie-breaking vote that has never been utilized, and certain user fees for products traded on fewer than all of the exchanges are determined only by those exchanges that trade these products. Again, if there is a problem under the equities plans with the special authority of the single market designated as plan administrator, I believe we should focus on that problem and not be too ready to discard totally a governance system that for the most part has worked well.
Finally, turning to the questions that have been raised concerning user fees charged by under all of the plans, I look forward to discussing these difficult questions at future meetings of the Committee, which I plan to attend in person. For now, let me say that users of market information benefit not only as a result of the direct costs incurred by the markets to make the information available, but also as a result of costs incurred by the markets to assure that their markets serve a valid price discovery function. These include the operational and regulatory costs of providing fair and orderly markets and the costs of collecting trade and quotation reports on a correct and timely basis, so that disseminated prices and quotations are a true reflection of supply and demand. Since users of market information benefit from all of these costs, it is only fair that they share in them to some extent. If no part of these costs could be recovered from information fees, but had to be entirely recovered from transaction fees and other revenue sources, then persons who use market information in a manner that is not necessarily reflected in the extent to which they actually trade in the market (and therefore pay transaction fees) will effectively be subsidized by persons who do trade in the market and will have to pay higher transaction fees. I do not believe this would be a fair or desirable result.
Again, I regret being unable to attend the April 12 meeting. I look forward to attending future meetings, and otherwise participating in the work of the Committee.
/s/ Edward J. Joyce
Edward J. Joyce