Speech by SEC Chairman:
Opening Statement at the Regulation NMS Hearing
Chairman William H. Donaldson
U.S. Securities & Exchange Commission
New York, New York
April 21, 2004
On behalf of the Securities and Exchange Commission, I would like to welcome our panelists and thank them in advance for their participation in today's hearing on Regulation NMS. Reg NMS was proposed by the Commission for comment in February and aims to modernize the regulatory framework for the National Market System.
I also want to welcome members of the public and other interested parties to today's hearing. Although the format of the hearing restricts participation and discussion to the panelists, it is our hope that the proceedings will inform and stimulate observation and reflection by all who are attending today. We hope too that we will have the full benefit of your thoughts - via written submissions during the formal comment period and through ongoing discussions and consultations.
The National Market System was mandated by Congress in 1975 and laid the foundation for competition among markets trading the same securities, while preserving wherever possible and practical the benefits of order interaction and price competition. The National Market System relies on -
- Public display of firm, accessible quotations in a consistent format;
- Immediate display of orders to trade at or better than a specified price, commonly known as "limit orders";
- Consolidated publication of market quotation and trade data in a form that is both reliable and widely available;
- Linkages between markets trading the same securities in order to foster efficiency and competition; and
- In the exchange markets, rules that are designed to ensure that the best quote is honored before trades are executed at inferior prices.
In general, our system of multiple, competing markets has worked remarkably well. Our markets are among the world's most competitive and efficient. Competition among markets has fostered technological innovation and the creation of trading platforms and order routing systems that address the needs of all types of investors regardless of size and sophistication. Investor participation in the markets has exploded in the last decade.
Over the past decade, however, there have been significant developments in our markets that threaten to erode the efficient functioning of the national market system regulatory structure:
- Advances in trading technology have led to the development of new, alternative trading venues -- particularly Electronic Communications Networks, or ECNs. Their instantaneous electronic capabilities often do not interact seamlessly with floor-based exchanges, and vice versa.
- The number of trading venues has increased, and it has become more and more complicated and costly to access them, as some market centers charge fees to access liquidity. These fees not only raise trading costs, but also cause identical published quotations to reflect significantly different true prices.
- Revenue from the dissemination of market data has become a significant funding source for SROs, giving them powerful incentives to maximize reported trade volume. In turn, the structure of these incentives has produced problematic practices such as so-called "wash trades" and "shredding" simply as ways to generate more "tape prints" and thus more market data revenue.
- The growth in subpenny trading has increased the risk that trivial quote increments will be used to step ahead of limit orders. Limit orders have already been discouraged by decimalization, and the opportunities to "step ahead" of the trade increase geometrically in a subpenny environment.
Regulation NMS, as currently proposed, grew out of considerable preliminary fact-finding efforts and extensive discussions with industry participants, and represents the critical next step toward resolution of these issues. In brief, the regulation in its current form is designed to encourage honoring the best price between markets by establishing a uniform trade-through rule for both exchange and Nasdaq listed securities, with proposed exceptions for slow markets and informed investor opt-outs. It seeks to address the issues of efficient access between markets and inconsistent quote prices by establishing a uniform market center access rule with a de minimis fee standard. It proposes to ban the display of sub-penny quotes in most stocks. And it would alter the rules concerning how market data is disseminated and priced.
Regulation NMS was intended to advance the discussion by setting forth concrete proposals and then subjecting them to wide-ranging questions and critique. While its publication was a critical step forward -- focusing public comments on these critical market structure issues - I want to emphasize that the Commission has, in no way, reached final decisions on any of the proposals' provisions. We are fully aware that these rules are complex and may have consequences not contemplated by the drafters of the proposals.
The purpose of this hearing is to broaden the dialogue with respect to our proposals. We intend to use this opportunity to probe your responses and ensure that we understand the informed, analytical, and factual underpinnings of your observations. We will use this hearing, the written comments that we have already received, the comments will receive subsequent to the hearing, and the results of a continuing process of consultation, to obtain insights to help us determine whether to adopt or modify the Regulation NMS proposals.
To say that market structure issues are complex and controversial is an understatement. So the perspectives of the market participants here today and of those who submit comments to the Commission are vital to assess the impact of the choices implicit in the proposals. The efficient functioning of our capital markets has intense public policy aspects. For example, advantage obtained by some market participants at the expense of another subset of participants must be balanced against public policy mandates of fairness to all - and not just those directly involved in a particular transaction. So I would ask that you put on your public policy hats for today's hearing. You can help the Commission by putting yourself in our shoes; you can help us by identifying the public policy goods that can be achieved by enacting the right and appropriate market structure rule proposals.
With the reminder that there will be plenty of opportunity during the comment period to assess the fairness of the economic impact of these proposals on certain industry participants, I would ask that in your responses today, you to try to put aside your institutional interests, your biases, and even your current business models. I would ask that you set time-worn and all-too-familiar rhetoric to the side, and instead give us the benefit of your frank (and succinct) insights about how the proposals, and the alternatives to the proposals, will serve our capital markets and the investing public from a public policy perspective.
With that opening plea, if you will, I believe that the time for considering market structure issues is now, and I very much look forward to delving deeply into these issues with you during today's hearing.