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15 January 2013

The Year of the Snake: Is Radical Change In Store for the Equity Markets?

Equities volumes dropped sharply in 2012, and market problems were as evident as ever. Will 2013 be the year in which regulators finally address market structure issues such as dark pools and fragmentation?

Overall US equity volumes for 2012 declined 18.5%, averaging about 6.5 billion shares a day. Interestingly, as quiet as equity volumes were last year, the volume of chatter around the markets was louder than ever. Several events in 2012 caught the public’s attention, and not in a good way.

Equity markets have a long history, and they often have been referred to as a well-oiled machine. But a number of malfunctions and investigations across trading venues have thrown a monkey wrench in the works. From the botched Facebook IPO, to Knight’s rogue algorithm, to the various dark pool investigations, each incident was damaging in its own right; but collectively, they have made it clear that some measures must be taken to address the current structure of the equity markets and boost market confidence.

[Related:Changing the Equity Market by Fixing Broken Windows”]

Perhaps the lack of volume has put unbearable pressure on trading venues to come up with new and creative ways to amass liquidity. Brokers and exchanges are constantly trying to figure out any way possible to bring liquidity to their customers, and now the ways in which they attract and aggregate that liquidity are coming under scrutiny. Innovation is a good thing -- but not when it hurts investors, and this is at the heart of regulators’ concerns.

In addition, the battle between lit and dark markets continues to fracture the industry. Both sides offer fair arguments for why they benefit the markets; but the contentious debate leaves everyone open for more in-depth examination. Regulators are left with no choice but to take a hard look at both lit and dark markets. In December, a congressional hearing focused on computerized trading and dark pools, and more recently, FINRA announced its plans to examine dark pools and how they operate.

[TABB Group continues to track the monthly volumes on lit and dark markets. Check out our Equities LiquidityMatrix report for more information.]

It’s not just dark pools that are facing scrutiny -- everyone is under the microscope -- and the media hounds are quicker than ever before to pick up the story. Just last week, news hit that BATS Exchange revealed it had an internal system error that led to pricing errors. While the exchange can expect regulatory fallout, hopefully it will bounce back fairly quickly. Knight and LeveL ATS both experienced blows to trading volume in 2012 following negative press, but both are seeing trading on their venues steadily climb back as they reassure customers that their markets are safe places to trade.

While regulators may have had bigger fish to fry over the past few years with Dodd-Frank at the forefront of debate, exchanges and dark pools seem to be officially back on the docket. Enough clarification from market participants on definitions and mechanics has been offered up to put regulators in a better position to make hard decisions around market structure. But will anything actually be done this year?

Regulation is slow to come, and I think it is doubtful that any meaningful changes will be enacted this year. But my colleague tells me 2013 is the Chinese Year of the Snake, and that means radical change, so perhaps I’m wrong. What do you think?

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4 Comments to "The Year of the Snake: Is Radical Change In Store for the Equity Markets?":
  • Comment_230146_210851315613283_100000652474653_678322_2285980_n

    16 January 2013

    one of main issues are its pryamid of command .. At a TABB debate yesterday it was pretty clear that regulators are totally unwilling or unable to interfere with exchange structure !

    Therefore if one exchange allows "abuse = libor then regulators are unable to act at source . It appears no one is in charge overall therefore making manipulation go undetected longer .

    I find it strange how ANY sane regulator allowed "dark pools " to exist and predict these to be the problem in 2013 as I believe HFT is now history ; and not a good or legal one .

  • Missing

    16 January 2013

    Pragma has just published some interesting research on HFT and commented on fragmentation and regulatory direction -- see my post

  • Comment_web_blue_photo_dks

    16 January 2013

    At a minimum, it appears the fragmentation pendulum has swung as far left as it is going to. It wouldnt surprise me to see consolidations between venues ahead of actual regulation.

  • Missing

    16 January 2013

    Somehow it appears that many if not all of the people who write for and comment at this site don't have a clue why individual investors have pulled out of the market.   In my 3 years in the market since retiring it has never been a "well oiled machine".  Have you not heard of the flash crash on May 6, 2010 when it was the individual investors who lost more than the 200 million dollars Ms. Schapiro estimated in her speech?  Have you not heard about something called direct digital control in which a computer adjusts downward the temperature of a reactor (read a stock's price) by adjusting the manipulated variable of the amount of cooling water circulated (read the number of shares a naked short seller offers for sale)?  Have you not read Senator Kaufman or R. T. Leuchtkafer's comments on market structure.  Did you not read the recent report by Kirilenko stating that HFT's hurt investors.  Individual investors are not as stupid as market "professionals" would hope.  Ms. Schapiro at least had a clue as to what was going on way back in September 2010 when she spoke to the Economic Club of New York -- even if the SEC has done nothing about it.  

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