SEC'S Paredes: Fragmentation Or Choice?
September 21, 2012
WASHINGTON, D.C. -- A dozen national exchanges. More than 40 dark pools and alternative venues. A couple hundred internal broker order-matching systems.
That, compared to a quarter century ago, when three national exchanges handled almost all order flow, is now often called ‘’fragmentation’’ by trading firms.
But should it?
Not necessarily, Securities and Exchange Commission member Troy Paredes said Friday morning at the Security Traders Association conference here.
“When I hear the word ‘fragmentation,’ it usually seems to be with a pejorative attached to it, a negative connotation,’’ he said. “That somehow fragmentation is a problem, that somehow fragmentation is troubling.’’
Fragmentation may have led to the fragmenting of orders into smaller transaction sizes, as firms seek best prices across all venues as part of the requirements of Regulation National Market System rules. And, when technical disruptions occur, the lack of unified rules about how to break trades can surface, as happened in the flash crash of May 6, 2010.
“While nothing is perfect by any means, I usually think about it in a somewhat different way,’’ Paredes said.
“In equity markets, where you have fragmentation, where you have many many different pools of liquidity, and you couple that with very low search costs, that begets competition and choice.’’
The “virtues of competition and choice,” he said, lets investors express themselves diverse interests, prefrences and strategies. The variety allows investors to access markets in ways that best fit their needs. “I think of that as being a good thing.’’
By calling it ‘fragmentation’ and pointing to the “risks that can sometimes present themselves,’’ he said, many investors can get “a skewed understanding of what is really the lay of the land.’’
There is no doubt that the speed of executing trades is up and bid-offer spreads are down, said Jamie Brigagliano, a partner at the Sidley Austin law firm and former deputy director of the Division of Trading and Markets at the SEC.
Indeed, the cost of trading a share of stock dropped more than two-thirds from 1999 to 2009, according to David Xiao, former director of global portfolio trading strategies at Citigroup. Using a $1 billion basket of Standard & Poor’s 500 stocks, he found that spreads went from 70 basis points a share in 1999 to 3.5 basis points a share in 2009 and “liquidity costs” – the market impact or slippage in price from start to end of a trade – fell from 42 basis points a share to 33 basis points.
Brigagliano called increased competition and choice “a thousand flowers approach” to market structure.
He suggested it may be harder for regulators to add safeguards when the markets are so complex.
And Paredes said it may be difficult to properly diagnose problems and to anticipated how a change in one market may affect another market.
But, he said, more data will be coming in to the SEC to help analyze what’s going on. The commission is requiring more details on the biggest trading firms, with its Large Trader Reporting Rule. In July, the commission also passed a consolidated audit trail rule that will require equity and option exchanges to deliver order and transaction details from equities and options markets overnight.