ZICKLIN SCHOOL OF BUSINESS
Department of Economics and Finance
17 Lexington Avenue, Box E0621
New York, NY 10010
Daniel G. Weaver
Associate Professor of Finance
November 23, 1998
Mr. Jonathan Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: File No. S7-12-98
Dear Secretary Katz:
I am an active teacher and researcher in the area of market microstructure. An area of microstructure that interests me is transparency. I have co-authored two papers on the subject: "Post-trade transparency on Nasdaq’s national market system," which is forthcoming in the Journal of Financial Economics: and "Transparency and Liquidity: Should US Markets Be More Transparent?" which is a working paper. The former deals with trade disclosure while the latter deals with order disclosure. I have also studied transparency issues in overseas markets. Therefore, I feel I am qualified to opine on the issue of order disclosure.
In the above mention SEC document, the commission asks for comments on whether non-dealer orders on ATSs that are at the inside should be fully disclosed. In particular the proposed rules release states that
"The Commission, however, requests comment on whether alternative trading systems should be required to display the full size of the best priced order, even if the full size is hidden from alternative trading system subscribers through use of a "reserve size" or similar feature."
Although the theoretical implications of such a "full display rule" (FDR) are debatable, I will focus on far more pragmatic issues. If the commission implements the FDR, I predict that in the short run institutions will move their trading upstairs. This will dramatically increase the price impact portion of large trade execution costs since information leakage will rise (Instinet began because institutions wanted an anonymous way to trade large blocks of stocks thereby minimizing information leakage). I think the path of trading system evolution will then take one of two routes.
First, as trading costs in Nasdaq stocks rise (the rule largely applies to Nasdaq ATSs), fewer institutions will trade them. The NYSE has a convert and participate (CapD) order that is similar to an ATS reserve function so institutions will find lower execution costs on the NYSE (the existence of CapD orders on the NYSE may be why Instinet has such little NYSE volume). Therefore, in an effort to attract institutional interest in their stocks, I predict that firms will begin an exodus from Nasdaq to list on the institutional friendly NYSE. In effect, the commission will have unintentionally created an unlevel playing field in favor of the NYSE.
The second path that trade system evolution may take is offshore. Adopting a FDR may simply result in Instinet moving their Nasdaq trading operations to London (the technology exists for transparent trading locations and the Commission has admitted that it is hard pressed to prevent foreign broker entry into the U.S. via the internet). This will further fragment order flow, which seems contrary to the Commission’s unspoken goal of consolidating order flow. In addition, if block trading moves offshore it will cause major harm to the U.S. price discovery process. Given that trades are the best predictor of prices, the fact that London Stock Exchange trades can take up to a week to be disclosed will make price discovery far less efficient.
I therefore urge the Commission to not require full disclosure of ATS orders. As a country, we need to start thinking of how we can attract liquidity in an increasingly borderless marketplace instead of attempting to mandate it.
Daniel G. Weaver, Ph.D.