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SEC’s Gensler speaks Wednesday, and rules that overhaul market operations could be coming

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Gary Gensler, the chairman of U.S. Securities and Exchange Commission, (SEC) at Washington, D.C., U.S.A on Thursday, Jul 22, 2021.

Melissa Lyttle | Bloomberg | Getty Images

SEC Chair Gary GenslerHe’s trying to keep his word on the need to correct what he considers to be deficiencies in U.S. commerce system.

The Securities and Exchange Commission publishes a “Rule List” each fall. This is basically a list of proposed rule changes that the agency wants to implement. Gensler has released the fall list for 2021. almost 50 proposed rule changesOne of the most comprehensive lists for decades.

It also includes the following proposal: “The Division is considering recommending that the Commission propose rule amendments to modernize rules related to equity market structure such as those relating to order routing, conflicts of interest, best execution, market concentration, and the disclosure of best execution statistics.”

While the SEC has been silent so far on what they are proposing to do, industry participants have quietly been saying that Gensler will likely use a speech at the Piper Sandler Global Exchange & Brokerage Conference on Wednesday to float several proposals. 

This could include the best execution or payment for order flow.

For order flow, best execution and payment

Gensler is critical of the inability of investors to understand what they pay for when they trade. Gensler wants investors to have greater transparency about the execution of trades and how much they cost. 

He is particularly concerned about the payment for orders flow (PFOF), where brokers are paid for sending their orders to market maker. This allows for some brokers to charge zero commissions. Gensler said that there could be conflicts of interests for brokers, and that too many market makers have too much power.

Industry participants believe Gensler might propose to crack this concentration by routing retail orders to an exchange or an automated trading platform. This would create a large pool of liquidity and allow for retailers to place orders.

Gensler could also ban payment for order flow, but it’s unclear. Exchanges such as the NYSE or Nasdaq offer payment for order flow through rebates that customers send to them. Any ban on this would be likely to be challenged by many parties including exchanges.

His demand for more transparency in trading and payment will be met by Gensler. Gensler might propose to tighten the rules for best execution. This is the duty to offer the most competitive prices when execution takes place. Gensler may request more information to explain the obligations broker-dealers have, such as price improvement or payment for order flow. 

Gensler might request more information about how investors are informed of the trading costs. For instance, an investor may pay $10 to trade but only $2 for order flow.  

This industry is pushing back

Gensler was urged by the industry to avoid altering an already complex system. They claim it is very beneficial for retailers.

A spokesperson for Citadel, one of the largest wholesalers participating in payment for order flow, released the following statement to CNBC: “It is important to recognize that the current market structure has resulted in tighter spreads, greater transparency, and meaningfully reduced costs for retail investors. We are looking forward to reviewing all proposals and working closely with the SEC, the industry, and achieving our long-held goal of further improving competition transparency.

Others in the U.S. trade system have echoed this caution.

Ken Bentsen (President and CEO, Securities Industry and Financial Markets Association) told me that “you need to be very deliberate about that approach.” He spoke of this in February.

“We’ve been calling for an overhaul of the market structure for some while, but we need to be cautious not to fix something that isn’t broken,” he stated. Retail investors are getting better deals than ever before.

Trades on the traditional “lit” exchanges will be more common

Gensler was also critical of the rise of off-exchange trading and dark pools, now accounting for around 40% of trading volume.

Gensler could propose harmonization rules for governing minimum trade sizes to counter this. Orders can be placed by exchanges in increments of one penny. However, orders from off-exchange parties are allowed. Gensler wants the level playing field to be equal. All trading can occur in the exact same increment and in any increment lower than a penny.

Gensler thinks that trading in equal amounts (say one-tenth to a penny) would increase the chance of rebates being reduced and that more trading would take place on traditional “lit” markets.

Are you looking for a definitive rule or just a test balloon?

Participants in the industry were unsure if Gensler would propose a complete set of market structures.

“It’s not clear if Gensler is proposing a rule change immediately or merely floating a ‘trial balloon’ that may result in a rules proposal sometime later in the year,” David Franasiak, an attorney with Williams & Jensen who follows corporate issues in Washington, told me.

Gensler’s only proposal for market structure

Gensler is considering this as one of the many regulations he has in his plans.

Amy Lynch of FrontLine Compliance told me in February that “this is the biggest regulatory agenda we’ve seen from the SEC for many years.”

The agenda has only grown since then. Gensler proposed regulations on cybersecurity risk management. He also suggested rules for loaning and borrowing securities. Gensler recommended reporting short positions by investment mangers. Shortening stock trading’s settlement cycle. Pay versus performance of corporate executives. Gensler enhanced disclosure about special purpose acquisitions companies.

One of the most controversial proposals – a proposed rule on the disclosure of climate change risks – is now open to the public for comment until June 17. Others proposals of “ESG” type are board diversity (disclosure regarding the diversity among board members and nominees), and human resource management (increased disclosure on how companies manage its workforce).

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