The SEC’s role in building better markets

October 11, 2013

The SEC has just launched a new part of its website dedicated to analyzing the structure of equity markets. Here is how the SEC describes it:

The Securities and Exchange Commission created this website to promote better understanding of our equity markets and equity market structure through the use of data and analytics.

Review current staff market structure research, use interactive data visualization tools to explore a variety of advanced market metrics produced from the Commission’s Market Information Data and Analytics System (MIDAS), download dozens of data sets to perform your own analyses, and further the dialogue through public feedback.

This is a big step for the SEC. There have been problems in equity markets with high frequency trading, flash crashes and exchange failures. Often these are technology-related issues. Getting the information, research and rules out into the public is a good start in beginning to rationalize market structure.

The SEC should expand this part of the website to include information and data on the market structure of fixed income securities. Although they don’t have the technology problems that equity markets have, there is opacity in various parts of the market. There is no central place to find authoritative data on the sizes of bond markets and how efficiently pre- and post-trade pricing systems work. As I wrote to the Commission in 2008, referencing a speech made by former SEC Commissioner Laura Unger in 1999 (emphasis mine):

“…In adopting the 1975 Amendments to the Securities Laws, Congress gave the Commission the authority to facilitate developing a national market system for securities. Not just equities, mind you, but all types, including fixed income securities. Congress recognized that many of the goals of a national market system were universal ones, such as transparency of quote and trade information, giving investors the opportunity for best execution, self-regulatory coordination, and strengthening Commission oversight of the markets.

At the same time, Congress made clear that it didn’t intend for the Commission to force all securities markets into a single mold. The Commission was to classify markets and take into account the differences among them in achieving the goals of a national market system….”

The assumption has always been that the SEC operates fairly and openly in supervising fixed income markets, but after the recent Libor-fixing allegations and various problems in the municipal markets, it’s clear that these markets would benefit from more scrutiny.

For example, the Municipal Securities Rulemaking Board is crafting a new rule about “best execution” for dealer trades to retail investors. The dealer group Sifma is proposing an approach called “execution with diligence”. I wrote last July:

The SIFMA proposal for ‘execution with diligence’ relies entirely on non-public market information and conflicts directly with the SEC’s intent of moving pre-trade information (i.e. aggregated bid/offer data) into the public domain. From the WSJ again:

As part of a sweeping SEC initiative to boost transparency in the muni market, the agency last summer asked the MSRB to ‘promptly’ ensure retail investors have better access to pretrade pricing information, including benchmark information. The MSRB was asked to post the pricing information on an online web portal, which collects and publishes muni disclosures and trade data.

Now the Bond Buyer is reporting that Sifma does not intend the “best execution” rule to rely on comparisons between trade prices. From the Bond Buyer (emphasis mine):

SIFMA previously provided the MSRB with a list of factors dealers should consider when making a determination about prices being reasonable, including the market for the muni, the demand for it, the availability of it, the price, the volatility of the market, and more. David Cohen, a SIFMA managing director and associate general counsel said the MSRB should stay away from relying too heavily on the prices reported from other trades.

SIFMA is rejecting a price reference approach for regulating best execution. This rule is a critical crossroads for municipal bond investors. If the SEC were to collect market structure data for the municipal market, then parsing out the various approaches to “best execution” could be done with evidence. What if the data showed that trades routed through a particular alternative trading system routinely had lower spreads for retail investors than equivalent trades done over the counter? This would have an enormous impact on helping shape market structure and investor protection.

Fixed income markets are more than double the size of equity markets. Congress has granted the SEC authority to oversee and regulate them. The first step is to collect and publish data about them.

Fixed income retail investors have suffered from opaque and unfair market practices. I encourage the SEC to make fair and transparent fixed income markets for retail investors an important and ongoing priority.

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