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Federal Advisory Committee on Market Information:New York Stock Exchange: Recommendation for a Competing Consolidators Model Robert G. Britz
February 15, 2001 Mr. Joel Seligman
Re: Comments on March 1 Agenda for Meeting of SEC Advisory Committee on Market Information Dear Dean Seligman: By your January 18 email forwarding the captioned agenda, you requested that we send to you our views on the alternatives that the agenda presents. This letter provides our responses. In that connection, I would like to express my appreciation for the several clarifying changes that you made in preparing the final agenda in response to our January 12 comments on the January 5 agenda draft. In response to the specific questions addressed to our competing consolidators model, we have attached Appendix A. Finally, the NYSE would appreciate the opportunity to serve on the subcommittee to be chaired by Professor Langevoort on alternative models. For ease of your review, we briefly summarize below each agenda item and then provide our responses. ITEM I. MANDATED DISPLAYSThis agenda item addresses two issues:
Changing the Current Display Requirements We believe that the availability of the consolidated last sale and the NBBO (a "consolidated service") to securities professionals and investors who seek consolidated data for business reasons or in compliance with their best-execution or other regulatory and fiduciary responsibilities remains vital to intermarket competition. The SEC has assured that availability at the "production" level by requiring, in essence, that SROs report quotes and trades and by approving SRO consortia that create consolidated feeds. It has assured that availability at the "distribution" level by precluding broker-dealers and vendors from providing individual market services without also providing consolidated services. As we explained in our December 1 letter to you, we are confident that the SEC can remove the consolidation requirements at the production level without impairing the availability of consolidated data. As to those requirements pertaining to joint contracting, joint pricing and revenue sharing, removing them poses zero risk to the availability of consolidated data. From a systems standpoint, the competing consolidators model does have some risks as to its accuracy, reliability and timeliness, but they are few, identifiable, familiar, extant in the current distribution chain and able to be mitigated. At the production level, we believe we are especially capable of assessing these risks since the NYSE along with our affiliate, the Securities Industry Automation Corporation ("SIAC"), have perhaps more firsthand institutional knowledge than any other organization. On the distribution level, we have discussed internally the spectrum of possibilities between preserving the display rule as it is today and removing it altogether. Possibilities within the spectrum include converting it from a must display ("push") rule to a must offer ("pull") rule (i.e., any vendor or broker-dealer who makes available any markets' last sale prices and quotes also must offer a consolidated service). We also recognize that any relaxation of the current rule introduces a greater degree of market discipline by requiring SROs to compete in presenting a value proposition for their data. But we do not yet believe we are capable of determining whether relaxing the rule will, in fact, impair the availability of consolidated data. At the distribution level, we do not have any unique institutional experience to make the requisite risk/reward calculation. We look forward to evaluating the thoughtful commentary on this agenda item of Committee representatives who are more directly involved at the distribution level. Regulating Other Data We recommend that any consideration of regulating other data beyond the current requirements of section 19(b) (requiring SROs to file with the SEC substantive rules and price changes) and of the SEC's Automation Review Policy ("ARP") should await experience with the SROs' voluntary and competitive dissemination of such data. The SROs should be given a chance to demonstrate that, as is currently the case for all other SRO activities except last sale prices and quotes, markets can competitively differentiate themselves on the basis of the information they provide to the benefit of investors. Our securities markets have never been more competitive. With the spreading of liquidity across six times as many price points and the disclosure of execution quality, markets are altering the way in which they conduct their business in an effort to enhance their competitive position, in no small measure by enhancing their value proposition through data offerings. This is already evident from several ECNs displaying their limit order books, as well as the data offerings that the NYSE and other markets are delivering in the next few months or have announced. ITEM II. CONSOLIDATIONAgenda Item II presents two primary alternatives:
Agenda Item II also presents the possibilities of:
Consortia As the next best alternative to permitting a SRO to withdraw from the consortia altogether (foreclosed in this exercise, but not in reality), we recommend permitting a SRO to establish data prices separately and enter into contracts separately, and thereby exit from revenue sharing. In these respects, our comments in our December 1 letter on the competing consolidators model apply. In effect, the sole remaining joint activity would be in regard to systems, as is the case with ITS. Each SRO would pay its allocated share of the costs of operating the consolidation and data feed system.1 Competitive Bidding In contrast to the OTC/UTP Plan, the CTA and CQ Plans currently permit the SROs to subject the exclusive consolidator function to competitive bidding.2 We would leave the decision whether to use competitive bidding in any particular two-year review cycle to the consortia's SROs. We understand that the OTC/UTP Plan SROs are seeking to achieve separation of NASDAQ's intra-market facilities from its inter-market facilities by selecting a new exclusive processor that is systemically independent from NASDAQ. While competitive bidding runs a poor second to competing consolidators, within the constraints of this exercise, we believe that a competitive bidding process should be used in the initial selection. Provisions for periodic review comparable to those of the CTA and CQ Plans should also be included in the OTC/UTP Plan. ECNs and Broker-Dealers The SEC's authority to permit or require joint action on national market system matters is limited to SROs. Thus, in the absence of a membership relationship, there is no statutory basis, and hence no antitrust protection, for a SRO to engage with broker-dealers in a market data consortium engaged in activities that inherently entail the creation of burdens on competition. For this and the regulatory reasons that we have made clear in past submissions to the SEC3, we cannot participate in a consolidation consortium that includes ECNs and other broker-dealers. That said, our members our obliged under Rules 60 and 128A to honor quotes made on the NYSE and to report trades executed on the NYSE to the NYSE. Apart from being intrinsic to the auction process, their compliance enables the NYSE to meet its obligations under SEC Rules 11Ac1-1 (the firm quote rule) and 11Aa3-1 (the transaction reporting rule). So long as they meet those obligations, we have no view as to permitting ECNs and broker-dealers to make available market data outside the continuing consortium postulated by this agenda item. However, any continuing consortium requirements applicable to SROs must also apply to ECNs and other broker-dealers acting through their SROs. Also as a matter of fair regulation, if the display rule is amended to permit broker-dealers and vendors to separately display the market data of a single ECN or other broker-dealer, then the rule should be concomitantly amended to permit broker-dealers and vendors to display the data of a single SRO. Individual SRO Dissemination in Addition to Consolidated Dissemination We cannot imagine any justification for precluding a SRO from making its own data available separately so long as it has enabled brokers and venders to comply with the display rule as it may be amended. ITEMS III & IV. GOVERNANCE AND SEC RATE REGULATIONAgenda Item III proposes alternatives for retaining or changing the current governance of the consortia with respect to (1) composition, (2) voting requirements and (3) admitting new entrants. Item IV looks at the same issue from the perspective of establishing fees and sharing revenues, raising the possibility of limiting fees to recovery of specified costs and allocating revenue sharing to fund "certain SRO functions". Item IV also suggests that each SRO might be permitted to separately sell its data to "the exclusive processor" on a wholesale basis. Preliminary Matters We note that:
Supra-SRO Governance, Direct SEC Rate Regulation and Funding Allocation The agenda's focus on the ministerial operating committees is misplaced, and becomes a pretext for supra-SRO and SEC intervention that, as we described in our response to the SEC Market Data Concept Release, is inefficient and counterproductive. We think SEC Chairman and Supreme Court Justice Douglas had it right 61 years ago when he described the genius of broker-dealers self-regulation under SEC oversight: [We let] the exchanges take the leadership with Government playing a residual role. Government would keep the shotgun, so to speak, behind the door, loaded, well-oiled, cleaned, and ready for use but with a hope it would never have to be used.5 While we are no match for Justice Douglas's eloquence, we tried to succinctly capture the checks and balances created by user allocation of NYSE costs in my brief letter of February 8 to Committee Members (attached for your convenience as Appendix B).
We believe our February 8 letter and our response to the SEC's Market Data Concept Release create a compelling case for leaving to our constituent Board the task of making funding decisions, allocating costs and denominating fees to effect that allocation. As we foreshadowed above in our discussion of preliminary matters, thoughtful people at the SROs and the SEC faced the identical set of issues in the mid-1970s and negotiated a governance mechanism that has served us well for more than 25 years. They have bequeathed to us a thoughtful system of checks and balances regarding CTA, including limited SRO delegation to the CTA operating committee, SRO veto of fee changes and other plan amendments, and the SEC's ability to override SRO vetoes, that serves to transmit user self-determination at the SRO level to the consortium. If we were to preserve the consortia, we ought not lightly to tamper with those checks and balances. For all these reasons, if the consortia do survive, we see no case for shifting the locus of decision making to the SRO consortia and for introducing representatives other than SRO delegates at the supra-SRO level. However, we wish to point out some of the practical consequences of attempting to effect that shift. The shift would require replicating the SRO governance system at the supra-SRO level. Apart from the changes to the 1934 Act, SEC rules and the joint venture agreements that this would entail, we doubt that a supra-SRO governance organization devoted to the narrow task of market data administration could attract the caliber of senior executives and public servants that serve on our Board.13 Moreover, such a shift would attenuate the cost allocation decision for the third of the NYSE's four largest revenue sources14 from the Exchange's budgetary and funding decision. It would also bifurcate between two user governance structures the allocation among listing, transaction and regulatory fees on the one hand and market data fees on the other hand. As noted, the consortium structures' user representatives would likely be of lower seniority and reduced breadth of view, and would operate out of pace with our Board, making appropriate sequencing difficult. The NASD's well-intentioned experiment with three boards (NASD, NASDR and NASDAQ) gives just a hint of the inefficiencies this introduces, and that occurred in an environment of 100 percent affiliation and a common chairman. New Entrants The CTA and CQ Plans have a provision that the SEC found in 1993 to "ensure that new market entrants are admitted to the plans on fair and reasonable terms". We believe that comparable provisions should be added to the OTC/UTP Plan.
Wholesaling to the Exclusive Processor
This proposal only makes sense in a competing consolidator model. Otherwise, the pricing of market data to end-users will have been moved from SROs (which is subject to constituent pricing determinations) to an entity that is subject neither to the existing discipline nor to the discipline of market forces. Thus, just as in the case of shifting the locus of decision making to the SRO consortia discussed above, this model would require the erection of new bureaucratic structures.
Item V seeks discussion on three unrelated categories of issues: (1) administrative issues, (2) technological issues and (3) pilot programs.
Preliminary Matter
Administrative and technological issues are fairly technical. Information about the current practices and technology and their rationale are not widely understood. Moreover, these matters are relatively peripheral to the structural issues covered by Items I - IV. Thus, we agree with the suggestion in your January 18 e-mail that some or all of these items might best be left for a subsequent meeting. We also encourage you to consider using two separate subcommittees, each of which includes organization representatives with the requisite knowledge of existing procedures and practicalities pertaining to the subcommittee's topic.
Administrative Issues
We remain committed to pursuing existing and appropriate new initiatives in this area.15
Technological Issues
The CTA and CQ systems, like NYSE systems, have no capacity constraints and we are unaware of any issues surrounding the accuracy and reliability of the data they produce. We are also unaware of any way in which they fall short on technologic innovation. The proposal to create an independent, competitively-bid exclusive processor function for the OTC/UTP Plan should place the dissemination of OTC/UTP stocks in a similar position.
Pilot Programs
The CTA pilot programs, which were effected pursuant to a SEC-approved provision of the CTA Plan, have served the industry well in responding to technological innovation given the cumbersome, multi-tiered approvals and reviews required for permanent plan amendments. We believe they should continue. We have no objection to appropriately changing those provisions so long as competitive initiatives do not have to be disclosed before introduction into the market place.16
* * *
I hope our responses prove helpful. We look forward to having an opportunity to discuss our responses and those of other members at the March 1 meeting.
Sincerely yours,
/s/ Robert G. Britz
Robert G. Britz
cc: Annette Nazareth
As matter of corporate structure, NASDAQ is now organized as a business corporation. We understand that, following its registration as a national securities exchange, the NASD will lose voting control over NASDAQ and that NASDAQ continues to seek to conduct an IPO. The NYSE has no plans either to separate its Regulatory Group or to change its organization as a membership co-operative precluded from distributing profits to its members by the New York Not-for-Profit Corporation Law.
By letter dated January 5, 2001, Annette Nazareth relayed Dean Seligman's request that NYSE respond in writing to certain questions regarding the competing consolidator model that NYSE proposed as an alternative to the current model in the December 1, 2000, letter from Robert G. Britz to Dean Seligman (the "Competing Consolidators Letter"). This Appendix A to NYSE's statements of position on the agenda items for the March 1, 2001, meeting of the SEC's Advisory Committee on Market Data (NYSE's "Agenda-Positions Letter") responds to those questions.
Question:
Under your model, would market centers other than SROs - such as ECNs, market makers and exchange specialists - be permitted to sell their data directly to vendors and data feed providers? If not, please explain why you believe the NYSE, for example, "owns" this data? Does the same rationale apply in the Nasdaq market?
NYSE Response:
In responding to agenda item I, the Agenda-Positions Letter explains that NYSE has no view regarding whether non-SRO market centers should be permitted to sell data directly to vendors and data feed providers outside of the data-dissemination consortia, as long as the regulatory scheme provides a level playing field.
Question:
Your model continues to rely on SEC oversight to ensure that each market's fees are fair and reasonable and not unreasonably discriminatory. What standards do you believe the SEC should use to make judgments as to the fairness and reasonableness of fees? Will this avoid the various problems with "government utility rate-making" you described in your comment letter to the Market Data Concept Release?
NYSE Response:
As our response to agenda items III and IV make clear, the NYSE's proposed model does not rely on SEC oversight. Instead, NYSE's proposal carries forward, and removes consortium interference with, the reliance on constituent governance that Congress legislated in 1975. Thus, the SEC should continue to discharge its responsibilities for overseeing the SROs' dissemination of market data in the same manner as it has overseen all SRO access and pricing matters for the past 26 years. However, it will be free of the "referee" responsibilities it has had to assume from time to time in respect to disputes among consortium SROs.
Question:
Should a market be permitted to impose restrictions on the recipients of its data, such as prohibiting them from making markets in the securities for which information is provided? If so, please justify the anticompetitive impact.
NYSE Response:
We understand these questions to express no concern with limitations on retransmission that require compliance with vendor-type contractual terms. With that understanding, NYSE's view is that a market should not restrict how a data recipient uses market data. However, note that differential pricing in accordance with the way data is used is a reasonable discrimination and an appropriate and long-established means for a SRO to allocate costs among its users.
Question:
By multiplying the number of direct data providers, won't your proposals introduce inefficiencies into the system? After all, vendors will be negotiating and servicing more contracts, the SEC will be reviewing more fee arrangements, and more parties will be consolidating the same data.
NYSE Response:
Regarding the proliferation of contracts, NYSE stated in the Competing Consolidators Letter (at footnote 15):
Under the extended competing consolidators model, the resulting change from joint contracts to individual exchange contracts could theoretically result in an increase from today's three sets to nine (11, taking into account the NASD and the International Securities Exchange, which is the sole options exchange that is not also a CTA/CQ Plan participant). However, if the industry's experience regarding the high level of conformity among the exchanges' rule books is predictive, those three sets would serve as models for all the exchanges, and the regional exchanges would tend to follow subsequent modifications to the three sets that the primary exchanges make.
This theoretical increase represents the worst case scenario. If regional exchanges continue to band together, such as by continuing to participate in CTA after NYSE's withdrawal, fewer contracts would be necessary.
Regarding SEC review, we note that the SEC already reviews each other type of fee of each SRO. No one has suggested that the SROs should form a consortium for joint SRO levying of transaction fees as a means of addressing the SEC's workload.
As for the portion of the question regarding the increase in the number of parties consolidating market data, the Competing Consolidator Letter points out that the costs incurred by the competing consolidator appear relatively small. "The joint costs of the collection, consolidation and dissemination functions are modest relative to the overall costs of producing and disseminating market data, and it appears that the unbundling of consortium costs may not raise them at all." (Competing Consolidators Letter at pp. 11-12; see, also, Competing Consolidators Letter at pp. 6-7.)
In any event, NYSE believes that the question is academic. We do not believe that the Commission can make a finding today that the 1934 Act purposes that joint activity serve outweigh the competitive burdens of joint activity. (See, for example, footnote 23 of the Competing Consolidators Letter.)
Question:
Your model explicitly is neutral on the issue of whether consolidated data must be provided to customers [fn. 12]. Does the NYSE have a view on this?
NYSE Response:
Please see our response to agenda item I in the Agenda-Positions Paper.
* * *
NYSE answers the following questions because NYSE's competing consolidator model contemplates that consolidated data displays should continue to be provided.
Question:
How will the SEC be assured that each of the competing consolidators is providing an accurate, reliable, and timely NBBO and last sale data? Your proposal raises the possibility of SEC regulation for non-exclusive SIPs. Please discuss your thoughts on this.
NYSE Response:
As the Competing Consolidator Letter explains (at pp. 10-11), the risks that could arise from NYSE's competing consolidator proposal regarding accuracy, reliability, and timeliness are few, identifiable, familiar, extant in the current distribution chain and able to be mitigated: "today's technology permits multiple entities to receive simultaneously multiple streams of data and to create consolidated outputs that sequence prices and quotes in the same order." The letter points out four types of risk -- different operating environments, different validation tolerances, separate capacity requirements for each consolidator and different protocols and data formats -- that a multi-consolidator environment will introduce, each of which is already present for data feed providers, vendors and other recipients. As the letter explains, CTA/CQ Plan resolutions of those issues are likely to carry forward under NYSE's proposal without intervention and market forces are likely to mitigate other disparities. As the letter also notes, standard setting, either through a trade group, contractual undertakings or, if necessary, direct SEC regulation, could intervene if additional regulation becomes necessary.
As NYSE sought to convey, NYSE does not believe that the need for SEC intervention is very high. The staff of the Securities Industry Automation Corporation would be pleased to meet with other Committee members and the SEC staff, or with Professor Langevoort's subcommittee on alternative models, to facilitate an assessment of the risks that could arise from NYSE's competing consolidator proposal regarding accuracy, reliability and timeliness, and how to mitigate these risks. We believe that the SEC will have to play no more than a reserve role.
Finally, we wish to note that deregulation always carries risks and costs in the nature of those that this question identifies. But here their impact is marginal and they are far more predictable than most since the U.S. securities industry is the exception in the world. The U.S. commodities futures industry and the rest of the world's securities and commodities futures industries have never been regulated in this fashion, thus presenting a $6.0 billion dollar industry in which competing data-feed providers pick up feeds from scores of exchanges that independently price, and contract with respect to, market data. The U.S. exception at the production (SRO) level represents only about $600 million (i.e., ten percent) of this experience base.1
Question:
If certain market data is required to be consolidated, should the price the individual markets are permitted to charge for it be more tightly controlled? In other words, won't a requirement to obtain data from every market encourage price-gouging?
NYSE Response:
See the Competing Consolidator Letter (pp.10 and 12), the letter from Robert G. Britz to Members of the SEC Advisory Committee on Market Data dated February 8, 2001 , and our response to items III and IV to the Agenda-Position Letter. Under NYSE's proposed model, the same forces that have prevented NYSE from exploiting any latent market power over the past seven decades will discipline NYSE's market data fees.
In addition, the injection of competition should also discipline pricing. As the Competing Consolidator Letter points out,
NYSE would compete with the other eight exchanges in the market data arena, just as it competes today with the other eight exchanges in individually in attracting listings and liquidity. Similarly, data feed providers would compete as to consolidation services, just as they do today as to other services.
* * *
NYSE does not respond to the remaining questions because NYSE's proposed competing consolidator model provides for the continuation of consolidated displays and, as discussed in our response to agenda item I, we have not yet come to a view on the disposition of the Display Rule.2
If consolidation were optional, how would this impact the best execution obligations of broker-dealers? If a broker-dealer elected to receive market information only from the largest market center, could this be sufficient for best execution? Or is the concept of best execution meaningless without an NBBO?
And what impact would this have on investors? If, for example, retail online investors were provided quotes from only one market center - that might have prices well away from the best - would they regularly and unwittingly trade at inferior prices?
If users were permitted to pick and choose the market centers from which they receive information, some might decide to pay for data only from the largest market center in a security. If this became prevalent, what would the competitive impact be on the smaller market centers? Would they be able to survive? Would it be feasible for new competitors to emerge?
Or would this lead to monopolies in the trading of individual securities? And what would this do to incentives to innovate, improve execution quality and reduce trading costs?
How can the SEC assure best execution and efficient price discovery without mandatory consolidated market information? Robert G. Britz
February 8, 2001
Re: Market Power in Pricing Market Data
Dear Members of the SEC Advisory Committee on Market Information:
During our December 14 meeting, several participants discussed the issue of "market power" as we move to a competitive market data landscape. Others voiced questions about the governance of the SRO consortia. It occurred to me that some of the comments might reflect an understandable lack of knowledge of the business history of CTA in particular, and of the governance process of CTA and its SRO participants.
As one of two dozen meeting participants, I did not want to take up others' time in making clarifying comments. Thus, I am writing now. Since the history, structure, corporate form and governance of CTA and the NYSE differ significantly and relevantly from those of the OTC/UTP dissemination and NASD/NASDAQ, I confine my remarks to CTA and the NYSE.
Any concern that the NYSE could and might exercise market power in a competitive environment for market data ignores 75 years of evidence to the contrary. It also ignores the discipline that derives from the constituent nature of NYSE governance. Moving to a competitive model will not relax that discipline.
NO EVIDENCE OF THE EXERCISE OF MARKET POWER
If the NYSE (or CTA) were exercising market power in the pricing of market data, one would expect, for example, a history of price increases. Yet, to the contrary, the prices for NYSE/CTA market data services have either declined or remained unchanged since the mid-1970s. That helps to explain why the cost of CTA market data has declined 81 percent over the past 15 years. That result is wholly inconsistent with the hypothesis of a dominant entity exercising market power.
Market power might also manifest itself as a rising contribution of market data fees to NYSE revenue. In fact, the proportion has oscillated between 15 and 17 percent since CTA's creation. That proportion long precedes the advent in the mid-1970s of both the CTA consortium and the SEC's oversight of market data fees: we have traced it back to the 1930s.
If there is latent market power, then something is disciplining its use.
USERS LEVY FEES ON THEMSELVES
The source of this discipline is no mystery. The NYSE does not so much establish prices as allocate costs. Constituent representatives establish NYSE prices by first determining the NYSE's funding needs, and then allocating the resulting costs among themselves.
Twenty-four men and women long experienced in business and the public sector -- 21 who are CEOs of users of Exchange services and three who are Public Directors with no financial interest in the outcome -- determine the Exchange's funding. They then allocate most of the non-regulatory costs of running the Exchange between listed companies and member broker-dealers (with institutional investors and other non-members contributing the balance) by establishing fees denominated as "listing fees", "transaction fees" and "market data fees". If they change the allocation, it must withstand scrutiny by constituent proxies -- Board representatives of potential "winners" and "losers" in the reallocation -- as well as by the Directors representing solely the public interest.
Board action is the last stop in our constituent process. Before the Board reallocates any costs, Exchange staff vets the proposed change with user groups. In the case of market data fees, the process includes our daily interaction with brokers (and vendors) in the course of our providing services to them, as well as our ongoing participation in industry associations. The NYSE staff seeks consensus by discussing new fee ideas with constituents who advocate their varying business models.
That this mechanism produces a fair result does not surprise economists. Through their proxies, the consumers of a complex, interdependent set of services determine what they pay. Congress recognized that this kind of competition among users produces the best and fairest allocation of costs: in 1975, it wrote into the 1934 Act requirements that exchanges afford fair representation of brokers, issuers and investors and fairly allocate costs among them.
Were the "belt" of constituent cost allocation ever to break, the SEC review process provides "suspenders". However, in the 26 years since Congress authorized the SEC to regulate market data fees, only once have the "suspenders" come into play -- not because of a failure of fair allocation, but because of a single user's campaign to avoid it.
I did not mention CTA in describing how costs are fairly allocated. This reflects reality. The SROs have never delegated fee matters to CTA: the SRO boards decide fee matters directly.
* * *
To be sure, adopting a competitive model will bring market forces to bear on market data pricing. But the primary discipline on any latent market power will remain the same: our constituents allocating the costs of running the Exchange among themselves. They arrive at fair allocation, not because of a statutory mandate or altruism, but because of the give-and-take among their Board representatives. These representatives recognize that their firms all benefit from funding the Exchange -- and that each user must contribute its fair share.
Simply put, those who approve the Exchange's budget and market data (and other) fees are the ones who pay. They can raise or lower any fee -- thereby reallocating among themselves the costs of operating the Exchange -- any time they want.
I hope the foregoing is helpful to you as the Committee pursues its important work.
Sincerely yours,
/s/ Robert G. Britz
Robert G. Britz
cc: Annette Nazareth
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