The Securities and Exchange Commission proposes a rule to increase competition for individual investor order execution.
A rule that would require certain orders of individual investors to be exposed to competition in fair and open auctions first, before such orders could be executed internally by any trading center that restricts order-by-order competition, was proposed by the Securities and Exchange Commission (SEC) today. The SEC’s proposed rule would take effect on January 1, 2019.
“The financial markets of today are not as open and competitive as they could be for individual investors, also known as retail investors. According to the Chair of the SEC, Gary Gensler, there is not a level playing field between the various parts of the market, including wholesalers, dark pools, and lit exchanges.
This is one of the reasons why this is the case. “Additionally, the markets have become increasingly obscured from view, which is especially problematic for individual investors. These common people who invest their own money don’t get the full benefit of different market participants competing to execute their marketable orders at the best possible price.
As a result, the intention behind this proposal is to increase the amount of competition that exists in the market for retail market orders. I believe that it would be beneficial for both the market as a whole and for individual investors on a day-to-day basis to permit the broader market to compete for their orders.
When individual investors want to trade immediately at the best prices currently available on the market, they can use marketable orders to trade in stocks that are listed on U.S. securities exchanges (also known as NMS stocks).
At the moment, retail brokers send more than ninety percent of these orders to a relatively small group of off-exchange dealers who are collectively referred to as wholesalers. This practice is known as a type of segmentation and reflects the fact that these orders impose lower costs on liquidity providers as compared to unsegmented order flow. Segmentation can also refer to the act of separating orders into distinct groups.
Wholesalers typically execute the marketable orders of individual investors internally, but they don’t give other market participants any chance to compete by offering better prices. This is because wholesalers don’t provide any opportunity for price competition. Because of this, these orders are not only separated from one another, but they are also shielded from the competition that occurs order-by-order.
Although wholesalers offer a certain price improvement to these orders in comparison to prices that are available on national securities exchanges for unsegmented order flow, the data analysis that was conducted for the proposal suggests that the amount of price improvement falls short of what would be expected if these orders were subject to order-by-order competition.
This is because wholesalers offer a price improvement to these orders relative to prices that are available on national securities exchanges for unsegmented order flow. It is estimated that this “competitive shortfall” results in a yearly loss of $1.5 billion in revenue.
Orders for NMS stocks that are made for an account of a natural person or an account held in legal form on behalf of a natural person or group of related family members and in which the average daily number of trades executed in NMS stocks was less than 40 in each of the six preceding calendar months would be considered “segmented orders” under the proposed rule, which, if adopted, would generally prohibit a “restricted competition trading center” such as a wholesaler from internally executing.
The general prohibition would be subject to a few limited exceptions under the proposed rule, such as those that would apply to orders that were carried out at a price that was particularly advantageous for individual investors.
The proposing release has been posted on SEC.gov, and it is going to be posted in the Federal Register as well. The window for receiving comments from the general public will remain open until March 31, 2023, or for a period of sixty days after the proposing release has been published in the Federal Register, whichever comes first.
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