16 July 1998
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Dear Mr. Katz,
RE: FILE NO. 10-101
I write with regard to the Commissions Request for Comments on the application of Tradepoint Financial Networks for an exemption from registration under Section 5 of the Securities Exchange Act of 1934.
I am a US national who has been resident in the UK since 1986. I have closely followed the development of Tradepoint since 1994, and am very familiar with its trading system and operations as well its key personnel. I strongly support the companys application on the basis that it offers US institutional investors an excellent low-cost non-intermediated mechanism for trading UK stocks. As my research has documented, US fund managers which utilize direct-access electronic trading vehicles reduce their cost of trading significantly, and thereby increase returns for fundholders.
In my view, Tradepoint also represents a model for exchange governance which is exceptionally well suited to an electronic trading environment; one which I hope US exchanges will be encouraged to adopt in the future.
The traditional structure of an exchange as a mutual association controlled by intermediaries is a remnant of the pre-computer era, when traders had to meet on a physical trading floor to transact. Limitations of space required rationing access, which was done on the basis of selling memberships. The members necessarily then became intermediaries for other traders. In an electronic environment, access need not be limited to intermediaries, and significant trading cost reductions may be achieved by reducing unnecessary intermediation.
Tradepoint is a listed company with a diversified shareholder base, meaning that its business is not driven by the needs of intermediaries, whose interests often lead them to retard the innovation and disintermediation process. Indeed, every significant trading system innovation which has been introduced into the equity markets in the past 30 years has been developed by a private company, rather than a membership-based exchange.
Tradepoints "members" are in fact clients; clients who receive equal direct anonymous access to the central trading mechanism irrespective of their status as institutional investors or broker-dealers. The Exchange suffers from none of the conflicts of interest among member firms and non-member investors which are rife in traditional mutualized exchanges, and which necessitate their regulation by government as quasi-public utilities. Tradepoint has an unambiguous incentive to tailor its services to the needs of investors, rather than those whose profits derive from intermediating investor transactions.
In my view, the most noteworthy innovation which Tradepoint has introduced into their trading structures is free limit orders: that is, no charge is imposed on patient traders, who supply liquidity to the limit order book. Only market order traders, those who trade against these orders, pay an execution fee. Encouraging low-cost patient trading is good both for US fundholders and for Tradepoint as a company selling trading services.
Given the incentive structure under which Tradepoint executives operate, which derives directly from the Exchanges governance structure, it should be clear that the Exchange poses a relatively light burden on regulatory authorities. Tradepoints governance structure should be considered a model for new exchanges being developed around the world, and for regulators seeking to promote best practice in exchange operation. Indeed, the demutualization of the Stockholm, Helsinki, Copenhagen, Amsterdam, Italian and Australian exchanges detaching ownership from membership moves them significantly in the direction of Tradepoints model, and should be viewed as a highly welcome development by their respective statutory regulatory agencies.
Whereas it should be clear that I strongly support Tradepoints application for exemption from Section 5 registration, I would like to raise the longer-term issue of using "low volume" as the criterion upon which to base such exemptions. Both on the basis of logic and actual market developments, the Commissions approach strikes me as being fundamentally flawed.
Logically it is flawed because there is no basis for the underlying assumption that US investors are better protected when trading on a less liquid trading system than they would be trading on a more liquid one. Indeed, one could make a far stronger prima facie case for the reverse proposition.
It is also flawed in that US institutional investors are already trading directly on foreign exchanges which have not received Section 5 exemptions, via electronic brokerage systems. US companies such as Instinet and Lattice Trading are already providing direct electronic access from US institutional dealing desks into foreign trading systems, such as the London Stock Exchanges (LSE) SETS system. Thus, although the LSE is not currently authorized by the Commission to place SETS screens on institutional dealing desks in the United States, their members are providing screens which perform precisely the same function. In effect, then, the LSE is already providing the service for which Tradepoint is requesting Commission approval. The only difference is that US institutions using electronic access into SETS must pay brokerage fees to execute their orders, whereas Tradepoints US "members" will only pay fees to that exchange.
The above comments obviously touch directly on the issues raised in the Commissions Release No. 34-39884 on so-called "alternative trading systems" (ATS). Without seeking to delve too deeply into these issues here, I would simply wish to point out that technological developments have critically blurred many of the traditional functional distinctions between investors and intermediaries, and between intermediaries and exchanges, and therefore raise profound issues regarding the appropriateness of the current US market structure regulation regime. Rather than create a formalized structure for promoting regulatory arbitrage between National Securities Exchange (NSE) and ATS classifications, I believe that the Commission needs to consider seriously a much different approach. This would be to move market structure regulation towards a conventional anti-trust model. The public utility status of US exchanges is inconsistent with free competition among trading service providers. SRO responsibilities need to be hived off to create a level playing field with non-NSE service providers, and private data vendors and order routing facilitators allowed to supplant the rigid ITS/CQS/CTA regime. The current structure serves to keep the US markets fragmented, inhospitable to trading system innovation (particularly with regard to call market products), and excessively dependent on political rather than commercial direction.
If any further comments would be useful, I would be pleased to assist.
Benn Steil (Dr)
International Economics Programme
The Royal Institute of International Affairs
10 St Jamess Square
London SW1Y 4LE
tel: +44 171 957 5742
fax: +44 171 957 5710