Today’s legal and regulatory systems are tasked with ensuring that finance is fair. Gary Gensler, the head of the Securities and Exchange Commission, America’s markets watchdog, is not happy
Save time by listening to our audio articles as you multitaskToday’s legal and regulatory systems are tasked with ensuring that finance is fair. And Gary Gensler, the head of the Securities and Exchange Commission, America’s markets watchdog, is not happy. In a speech on June 8th he worried that “market segmentation and concentration” mean there is no longer a “level playing-field” in the stockmarket.
A fair market is transparent, accessible and uses a reasonable method to arrange buyers and sellers—think of a public farmers’ market with clearly stated prices and an orderly queue. A decade ago this was a decent description of most equity trades. Three-quarters of them, by volume, were conducted on public exchanges; only a quarter were done “off-exchange”. No more.
At first glance, this system is not obviously bad for retail investors. Brokers—Charles Schwab, say, or Robinhood—are obliged to seek “best execution” for their customers. In order to direct a retail order to a marketmaker, like Citadel Securities or Virtu, they must beat the prevailing price offered by public exchanges—the so-called “national best bid and offer” —a feature known as “price improvement”. That means retail traders probably get better prices than most institutions.
Yet there are flaws. Post-trade price improvement makes it impossible for punters to know ahead of trading which broker would ultimately give them the best execution price. As Mr Gensler put it, “price improvement without competition…is not necessarily the best price improvement.” Marketmakers and brokers might start to hang on to more of the benefits, instead of passing them on to punters.
One solution from Mr Gensler is for exchanges to hold auctions for retail stock orders, a practice typically used to fill retail orders for equity derivatives. By redirecting retail flows to exchanges, this would radically reshape American stockmarkets—to the benefit of exchanges and the detriment of marketmakers—and is therefore likely to be fiercely resisted.
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