The Unintended Consequence of Market Structure Reform: Cutting Out the Everyday Investor

Oliver Sung
October 24, 2023

American investors have never had better access to markets than they do today.

There is more choice than ever on where to trade and how, and many barriers that once shut out the everyday individual investor are gone. Most individual investors also have access to the U.S. equities market through passive investments in their 401(K)s and pensions—vehicles that help many Americans reach their goals. Collaboration between regulators and academia has allowed the U.S. equities industry to evolve greatly, improving accessibility while enhancing execution quality and liquidity, and maintaining safeguards that protect investors and the marketplace. This creates opportunities and enables individual retail investors to take matters into their own hands, with the freedom, access and ability to make informed decisions about their investments directly if they choose. This evolution of the equities markets will enable future generations to build better, more sustainable financial lives — if we keep that accessibility alive.

However, there is a growing trend around diminished volumes transacting through our national securities exchanges, which means less trading is occurring on transparent and well-regulated exchanges. Every day, every trade executed on exchanges is reported in real time and exchanges facilitate price formation by displaying competitive prices that drive price discovery. Not only are trades that occur on exchanges publicly visible, but regulators have full insight into those trades, ensuring that markets remain fair and orderly. This integral part of exchange trading is increasingly unappreciated, despite the incredible benefit it provides investors. Current SEC proposals to reduce access fee caps and eliminate certain volume-based pricing discounts could have the effect of further driving trading volumes to off-exchange venues. These well-intentioned proposals could actually have a negative impact on the markets — think wider spreads of the public quote, particularly in high-priced stocks.

Despite exchanges’ strength, accessibility and value, volumes continue to accumulate on over-the-counter (OTC) off-exchange venues that may not have regulatory filing requirements as extensive as registered exchanges, especially those not subject to Regulation ATS. While off-exchange market centers certainly have their place in our market landscape, major reforms may shift more volume off-exchange, undermining competition, weakening price formation and squandering important protections.

I love the dynamism of markets. For decades, I’ve been surrounded by people constantly working to improve equities markets. That innovative mindset fueled the growth of the U.S. equities market into the world’s most liquid, dynamic markets. Leading equities at Cboe Global Markets, I’ve seen firsthand how U.S. exchanges fight for the everyday investor. From developing innovative order types to proposing changes to outdated rules, exchanges strive to represent and protect end investors. Proposals that challenge exchanges’ ability to compete hinder these efforts.

Today’s U.S. equities market is not broken, as others seem to believe. Could pieces use some fine-tuning? Definitely. Does that require a disruptive overhaul? Absolutely not. Just like you don’t tear the whole house down when there’s a leak, we shouldn’t dismantle a strong framework because of some imperfections.

If exchanges are forced to significantly reduce access fees or cut rebates, they lose an important tool that facilitates liquidity provision and price discovery. In that environment, exchanges’ ability to effectively compete alongside off-exchange venues would be significantly impeded, which could lead to more volume migration, creating significant price discovery implications. Importantly, markets and end investors won’t fully benefit from the true transparency that is a hallmark of exchange trading. This isn’t the intention of the proposed reforms, but it will be the consequence.

The main justification in Regulation NMS in support of enacting access fee caps was to prevent outlier predatory pricing and facilitate effective intermarket linkages. Pushing to further reduce the cap entirely misses that point and ignores the benefits exchanges and their existing economic model provide to the marketplace. These efforts will likely be unproductive and fail to address any meaningful issues within the U.S. equities market landscape, leaving investors with higher costs and less choice.

Likewise, volume-based pricing tiers create competition between exchanges, and with non-exchange venues. These tiers follow a familiar economic model. It’s not unusual for retailers to incentivize shoppers to purchase more units of a product by offering a quantity-based discount. The same principle applies to equities markets. Rather than splitting trades across platforms, exchanges offer volume-based pricing to everyone to improve liquidity and attract volume that might otherwise execute off-exchange.

Proponents are missing the forest for the trees. These changes will have a deleterious effect on competition, driving more trading to undisclosed, less transparent, less accessible, less regulated trading venues. I think I’ve heard this story before, and I didn’t like the ending. We’ve long been vocal about the positive impact of more disclosures and greater transparency. The information needed to make this possible is readily available and would be the best way to determine whether reform is needed.

It would be disappointing to watch the SEC weaken the vibrant, open marketplace it worked so hard to protect. I sincerely hope this can be avoided through more measured reforms and a focus on where more regulation is truly needed.