Regulators should play to their strengths

By Felix Salmon
August 23, 2009
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The first thing that regulators do isn’t regulate: the first thing that regulators do is try to maximize their own power. Then, and only then, do they even think about using that power. Item:

The Securities and Exchange Commission says it is taking a close look at flash quotes, high-frequency trading and other dark corners of the stock markets.

But by many accounts, the agency is outmatched by the traders and market venues with technology that is remaking the trading world.

The agency lacks its own traders with knowledge about cutting-edge strategies and how the markets operate. It long ago ceded the daily surveillance of trading to self-regulatory organizations, like NYSE Regulation and the Financial Industry Regulatory Authority. And it takes a lawyerly approach to regulation and rule making that rarely employs deep analyses of real trading data.

The SEC has enough of a mountain to climb just trying to be effective at the stuff it already does: this kind of mission creep helps no one. It makes a certain amount of conceptual sense that the SEC should be regulating trading strategies, but it doesn’t make practical sense — not unless and until the SEC has proven that it’s more competent than this.

In the mean time, who best to keep an eye on high-frequency trading and the suchlike? Well, the CFTC might be one place to start, especially since in an ideal world the SEC and CFTC would be merged into one entity, and also since at least as much high-frequency trading goes on in commodities and derivatives markets as goes on in stock and bond markets. A bit more cooperation between the two would do no one any harm.

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