CHANGES IN THE MARKETPLACE. Market Structure Evolution

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Rosamond Daniels
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1 CHANGES IN THE MARKETPLACE Market Structure Evolution 1

2 CHANGES IN THE MARKETPLACE How the U.S. Markets Transformed Traditional Model Regulation Technology Current Model Orders centralized at listing market Markets operating manually Institutional and retail orders interact Common set of rules and practices Average trade = 1,500 shares Quotes stable and often for Size Quotes wide, +100 bps in large cap Blocks trade on Exchange Order fragmented over many markets 11 Exchanges & 40+ Broker Systems Retail orders trade Over-the-Counter(OTC) Diverse set of rules and practices Average trade size < 200 shares Quotes flicker and show little size Quotes narrow, 10 bps in large cap Blocks trade OTC, and only trade rarely 2

3 The Last 15 Years: The Cost of Trading has Fallen Competition between market centers and market makers has driven trading costs down for all investors. Automated firms are most active in the largest-cap, most actively traded stocks, where market quality is highest 3

Fragmented markets a reality for large and small cap

Nasdaq, NYSE, BATS, BATS Edge and others offer

Off-exchange trading (OTC) is reported through the two

Small caps are more likely to trade off-exchange than

US EQUITY MARKET VOLUME BREAKDOWN US EQUITY MARKET

TRF NYSE Arca NYSE Matched 8% 7% 13% 5% U.S. EQUITIES UNDER $750M 17% 2% 1.

32% 9% 40% Other Source: NYSE Broker Volume Reports,

Volume data represents percentage of total share

Internalized trades can be reported to the

4 Fragmented markets a reality for large and small cap The largest U.S. exchanges are Nasdaq and NYSE. Nasdaq, NYSE, BATS, BATS Edge and others offer electronic trading on order books. Off-exchange trading (OTC) is reported through the two Trade Reporting Facilities (TRF). Small caps are more likely to trade off-exchange than large cap. US EQUITY MARKET VOLUME BREAKDOWN US EQUITY MARKET VOLUME BREAKDOWN COMPANIES UNDER $750M 12% 12% 9% 3% ALL U.S. EQUITIES 17% 2% NASDAQ Matched NASDAQ BX FINRA/NASDAQ TRF NYSE Arca NYSE Matched 8% 7% 13% 5% U.S. EQUITIES UNDER $750M 17% 2% 1.32% 12% 32% BATS EDGE 1.32% 9% 40% Other Source: NYSE Broker Volume Reports, Nasdaq, Bloomberg, FactSet Research Systems. Volume data represents percentage of total share volume reported to the consolidated tape. Internalized trades can be reported to the FINRA/Nasdaq TRF, a trade reporting facility of the Financial Industry Regulatory Authority, Inc. that is operated by Nasdaq. Trades reported to the FINRA/Nasdaq TRF do not reflect liquidity available on the Nasdaq Exchange book data from February

5 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 Q1 '08 Q2 '08 Q3 '08 Q4 '09 Q1 '09 Q2 '09 Q3 '09 Q4 '10 Q1 '10 Q2 '10 Q3 '10 Q4 '11 Q1 '11 Q2 '11 Q3 '11 Q4 '12 Q1 '12 Q2 '12 Q3 '12 Q4 '13 Q1 '13 Q2 '13 Q3 '13 Q4 '14 Q1 '14 Q2 '14 Q3 '14 Q4 '15 Q1 '15 Q2 '15 Q3 Billions of Shares CHANGES IN THE MARKETPLACE Trading volume relatively flat since 2012 Trading volume in the U.S. is typically measured in shares. Equity market volume in the US surged with deregulation in the early 2000s and then again during the Global Financial Crisis. Following the crisis, trading volumes have been relatively stable NASDAQ-listed NYSE-listed AMEX/ARCA-listed 5

6 CHANGES IN THE MARKETPLACE How the Nordic Markets Transformed Traditional Model Regulation Technology Current Model Orders centralized at listing market Institutional and retail orders interact Markets automated Common set of rules and practices Average trade = large Quotes stable and often for Size Quotes +30 bps in large cap Blocks trade on Exchange Order fragmented over several markets Primary Exchange & 3 Broker Systems Diverse set of rules and practices Average trade size = smaller Quotes flicker and show less size Quotes narrow, 10 bps in large cap Blocks trade more frequently OTC 6

Competition between the primary market and the new entrants drove the change

7 Market Quality in the Nordics The quoted spread declined drastically in Stockholm and the other Nordic markets after MiFID. Competition between the primary market and the new entrants drove the change in trading increment (tick sizes). The change in trading increments drove other changes as well. Tick size change 7

8 CHANGES IN THE MARKETPLACE Nordic Trading Volume has Grown Trading volume in the Nordics is measured in value traded (turnover). Equity market volume in the Nordics did not surge with MiFID but fell with the Financial Crisis Following the crisis, trading volumes have been volatile but generally upward trending. 120,000,000,000 Turnover Eur 100,000,000,000 80,000,000,000 60,000,000,000 40,000,000,000 Turnover Eur 20,000,000,

9 Market Quality in the Nordics MiFID did not create a change in volatility when it was implemented. The introduction of a new high performance trading system did lead to a drop in volatility in % Average Intraday Volatility (%) OMXS30 constituents % 0.20% 0.15% 0.10% 0.05% 0.00% Standard deviation of the logarithmic returns in one minute intervals. Monthly averages are computed from daily values. 9

10 A Consequence of More Markets: More Orders High Frequency Trading (HFT) is often part of introducing competition The more competing markets, the more important is high frequency trading. The U.S. is not shown. There are 11 lit venues and the order to trade ratio is around

11 CHANGES IN THE MARKETPLACE Role of Best Execution in Driving Competition 11

12 4 GEOGRAPHIES 4 DIFFERENT GOALS United States: Best Execution rules used to both create competition and drive incumbent exchanges to automate. Europe: Best Execution rules used to both create competition and create a pan- European Market. (Not yet achieved) Canada: Best Execution rules used to create competition without destroying the domestic market. Australia: Best Execution rules used primarily to create competition. 12

13 Commonalities in Best Execution: Achieve the Best Possible Outcome for the Client Usually this means do no worse then the best price displayed in the market. Other Considerations are Size of the Order, Likelihood of Execution, Other costs besides trading price, Speed, Customer instructions, and Other circumstances. 13

14 THE DETAILS DEPEND ON PUBLIC POLICY AND HELP DETERMINE THE OUTCOME. United States: Manual markets would not have Protected prices. Other incentives to automate. Europe: MiFID I emphasis on market access for trading, clearing and settlement more than best execution. Canada: Special policies to try and avoid trading moving to the U.S. Preserve scale in Canadian markets. Australia: Introduced competition in multiple dimensions to diminish the influence of the incumbent. 14

SEC TICK SIZE PILOT MEASURING THE IMPACT OF CHANGING THE TICK SIZE ON THE LIQUIDITY AND TRADING OF SMALLER PUBLIC COMPANIES

SEC TICK SIZE PILOT MEASURING THE IMPACT OF CHANGING THE TICK SIZE ON THE LIQUIDITY AND TRADING OF SMALLER PUBLIC COMPANIES APRIL 7, 2017 On May 6, 2015, the Securities & Exchange Commission (SEC) issued