Ari Rubenstein’s testimony before the House Financial Services Committee Hearing on Market Structure
27 June 2017
Thank you Chairman Huizenga, Ranking Member Maloney and distinguished members of the Committee.
It is a personal honor for me to be here today to discuss with you these important market structure issues and how we can keep America #1 in capital markets and finance. Almost twenty-five years ago this summer, I started as a runner on the floor of the commodities exchange at the former World Trade Center, where the biggest piece of technology we had was a telephone. Approximately a decade later I felt technology could evolve our markets and bring enormous benefits to investors. At that point, I helped start my current company, GTS.
GTS is an electronic market maker. We provide offers to buy and sell thousands of investment instruments electronically across global markets. In the U.S. cash equity markets, on any given day we might trade between 3% and 5% of the consolidated daily volumes. All of our trading is quantitatively driven and automated using computers.
We are also the largest designated market maker (“DMM”) at the New York Stock Exchange. This means we are uniquely and directly responsible and accountable to over 900 public companies for making sure there is ample liquidity for their investors to access throughout the day. That list includes some well-known companies such as Exxon Mobil, Berkshire Hathaway, AT&T and 161 other companies in the S&P 500. Most recently, we handled the IPO of the tech company Snapchat, which was the largest IPO of the past 3 years and raised nearly four billion dollars for the company and its workers.
Our goal at GTS is to do for the capital markets what Amazon has done for online commerce: Use technology in a responsible way to promote efficiency for public companies, and save their investor’s money. We do this by adhering to our core principles of transparency and innovation. That yields investor confidence and lower costs. Our efforts help companies raise capital, grow and employ workers.
Evolution of our Capital Markets
We’ve witnessed the capital markets evolve tremendously since the days I was yelling buy and sell orders on the exchange floor. Like many industries, technology has transformed the business, making the markets more fair and efficient for all participants. And just like the conveniences and cost savings we enjoy using the internet and technology, the financial markets participate in the same way.
The emergence of advanced algorithmic trading, coupled with regulatory initiatives promulgated by the Securities and Exchange Commission (SEC) since 1996,1 have resulted in highly competitive equity markets, in which trading is dispersed across a wide variety of market centers ranging from public venues to private trading pools to individual broker-dealers. As a result, investors are doing much better in today’s algorithmic marketplace than they did in the old manual markets.2
For example, thanks to the advanced technology that electronic market makers have deployed, the cost to trade has declined dramatically. The average trading cost for investors has come down by more than 50 percent in the last 10 years.3 This results in more money in the accounts of investors when they retire. Due to today’s reduced trading costs, investments in a retirement account over a 30 year period, will end up with a 30 percent higher return.4
There were concerns late last decade that the vulnerability of electronic systems would pose a threat to the markets. These concerns, which arose as a consequence of some high- profile market disruptions, such as the “flash crash” in 2010 and the Knight Capital trading incident in 2012, led the SEC and the Financial Industry Regulatory Authority (FINRA) to enact rules to improve market infrastructure.
For instance, market access rules enacted in 2010 now ensure that broker-dealers with direct access to trading on an exchange or alternative trading system have procedures in place to effectively manage the financial, regulatory and other risks of this business activity;5 Regulation Systems Compliance and Integrity (Regulation SCI) enacted in 2014 strengthened the technology infrastructure of the U.S. securities markets by imposing requirements that reduce the occurrence of systems issues and improve resiliency when systems problems do occur;6 and rules adopted in 2016 put in place a plan to create a single, comprehensive database known as the consolidated audit trail that will enable regulators to more efficiently track all trading activity in the U.S. equity markets.7
These positive and necessary advancements to our market structure – among others8 – have resulted in tighter spreads, improved competition, improved operational resiliency and far greater efficiency.
Despite the improvements to our market structure, there is certainly more to be done. Former SEC Chair, Mary Jo White, said it best when she stated in a 2014 speech that “the current market structure is not fundamentally broken, let alone rigged. To the contrary, the equity markets are strong and generally continue to serve well the interests of both retail and institutional investors.” She went on to say that “the largely positive data on broad market quality does not mean, however, that the current market structure [cannot be improved].”9 I could not agree more.
However, we should not squander our resources trying to fix problems that don’t exist. I’ve witnessed a lot of alarms being rang for problems that really aren’t there, and then hear proposed solutions that are questionably positive in the grand scheme of things.
One example is a recent proposal by the BATS exchange to offer an alternative closing auction for securities listed on other markets.10 This is nothing more than a money grab for Wall Street that is striking fear in many of the public companies and their investors that we are here to serve.
While GTS agrees that fragmentation has generally been good for the U.S. markets, fragmenting order flow in the closing auctions – as the Bats proposal attempts to do – will rob issuers of the right to choose which exchange manages the closing auction of their shares. The closing auctions are one of the critical features of listing on an exchange. Issuers want a centralized closing process for their shares because of the integrity of the closing price derived by the centralized auctions. If we take away this most basic and fundamental feature of our equity market structure, issuers will have yet one more reason to forgo going public and listing on an exchange. This would be disastrous for the U.S. capital markets and for its investors.
There are multiple small, mid, and large cap companies extremely alarmed by the Bats proposal. I’ve outlined and cited much of this specific outcry in a letter I filed recently with the SEC, and have attached that letter as an appendix to this testimony.
So here’s what we should be spending our time on:
Greater Resilience to Cybersecurity Threats:
First, we need greater resilience to cybersecurity. This is often overlooked in the debate about market structure, but an all-electronic market, like many other technology- dependent sectors in the economy, needs to be vigilant on this issue. The SEC’s own cyber-security sweep conducted in 2014 revealed that, of the more than 100 companies examined, 88 percent of the broker-dealers and 74 percent of the investment advisers had experienced a cyber-attack.11
Despite great work that the regulators12 and industry have done, we need to double down on our efforts to prevent hacking and cyber-attacks. We need a better system for sharing information between key stakeholders, because we all have a collective interest in preventing such a problem.
Improve Investor Confidence by Identifying and Eliminating Fraud and Abuse:
Next, we need to do more to detect electronic trading fraud and abuse. I am a member of the FINRA market surveillance advisory group, whose goal is to assist FINRA in the construction of an advanced artificial intelligence (A.I.) and machine learning system to eradicate nefarious activity in our markets.13 This is a great and impressive start, but more time and budget is necessary to complete these projects.
By leveraging today’s technology, such as A.I. and machine learning, regulators and private industry can better identify and weed out bad actors in our markets. Doing so will improve investor confidence, which is essential to widespread participation in any market.
Improving the SIP:
And finally, we need to further improve the Securities Information Processor (SIP), which links the U.S. markets by processing and consolidating all protected bid/ask quotes and trades from every trading venue into a single, easily consumed data feed.
The SIP has been identified as a “single point of failure” by the SEC, which means it can halt or severely disrupt trading when a problem occurs.14 In addition, the SIP has been blamed for creating a two-speed marketplace since SIP data moves slower than exchange direct-feed data.
Investors need the most accurate information possible when making investment decisions. While investors and market participants have equal access to all publicly available data, the SIP is the most widely used and least expensive solution. The perception of a SIP feed that disseminates information at a significant disadvantage to direct feeds will eventually drain investor confidence. Therefore, regulators should consider proposals to further upgrade this critical piece of market infrastructure.
Our markets are stronger and more efficient than ever and certainly the envy of the world. But we should not rest on our laurels. We need to avoid potentially costly experiments, and instead use those scarce resource to improve the markets, which will help advance investor confidence.
Thanks to the innovative and principled hard work of smart dedicated people from the industry and the various regulatory bodies, we can deploy these changes from a position of strength.
I appreciate the opportunity to present my views to the Committee today and I look forward to answering any questions you may have.
1 Today’s U.S. equity market structure was shaped by four main regulatory initiatives, including the Order Handling Rules in 1996, Regulation ATS in 1998, Decimalization in 2000 and Regulation NMS in 2005.
2 In a speech on June 5, 204, former SEC Chair Mary Jo White highlighted lower execution costs, reduced intraday volatility and extremely narrow spreads as evidence that investors are better off in today’s algorithmic marketplace. You can view the speech here: https://www.sec.gov/news/speech/2014-spch060514mjw
3 Source: TABB Group Reg One Solutions, Effective/quoted spread for market orders of 100 – 1999 shares in the S&P 500. View the chart here: https://modernmarketsinitiative.org/wp-content/uploads/2016/03/Capture.jpg
4 Hal Scott, “Why U.S. Investors are Better Off Today,” Washington Times, January 21, 2016. According to the article, Vanguard estimates that the shift from the old market structure to today’s automated market structure has reduced trading costs by 35-60 percent, resulting in a 32% greater yield for long-term investors. View the article here: http://www.washingtontimes.com/news/2016/jan/21/hal-scott-why-us-investors-are-better-off-today/
5 View the SEC’s press release on Rule 15c3-5 here: https://www.sec.gov/news/press/2010/2010-210.htm
6 View the SEC’s press release on Regulation SCI here: https://www.sec.gov/news/press-release/2014-260
7 View the SEC’s press release on the Consolidated Audit Trail here: https://www.sec.gov/news/pressrelease/2016-240.html
8 Other regulatory initiatives that have improved market infrastructure include single stock and market-wide circuit breakers, “limit up-limit down” mechanisms for individual stocks, and large trade reporting improvements.
9 See a speech by Former SEC Chair, Mary Jo White, “Enhancing Our Equity Market Structure” delivered on June 5, 2014 here: https://www.sec.gov/news/speech/2014-spch060514mjw
10 View the Bats proposed rule to Introduce Bats Market Close here:
11 Craig Newman, “Securities and Exchange Commission Gets Tough on Cyber Security,” The Financial Times, January 17, 2016. View the article here: https://www.ft.com/content/d5eda03e-b87c-11e5-b151-8e15c9a029fb?mhq5j=e2
12 The SEC, for example, has created a senior role specifically dedicated to coordinating the Commission’s cybersecurity policy, has increased its attention to cyber threats with stepped up enforcement (see article above) and recently released its Office of Compliance Inspection and Examinations’ 2017 priorities, which underscore the importance of strong cybersecurity compliance procedures and controls. You can view the priorities here: http://www.sec.gov/news/pressrelease/2017-7.html
13 Learn more about the Market Surveillance Advisory Group in FINRA’s March 21, 2017 Special Notice here: http://www.finra.org/sites/default/files/notice_doc_file_ref/Special-Notice-032117.pdf