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1 May 2016 CFA Institute Journal Review

Share Trading: Complicate, Then Prevaricate (Digest Summary)

  1. Marc L. Ross, CFA

Efforts to create a more level playing field for share trading in the United States have so far had mixed results and unintended consequences.

What’s Inside?

Share trading seems to have evolved only so much. Just when things appear more transparent and simple, new complications arise.

How Is This Article Useful to Practitioners?

Share trading in the United States has made strides over the decades, but new concerns have come up. Trading costs have declined markedly over time because of increased competition and the addition of alternate venues. In 2005, the SEC adopted Regulation National Market System (NMS), which requires share-trading orders to be directed to the exchange that offers the best price. That rule broke the decades-old NYSE and NASDAQ duopoly. Both now have less than a 20% share of the market. Investors can purchase shares on numerous exchanges, alternative trading systems, and single-dealer platforms. Internalized trading occurs at large asset managers and banks that eschew outside trading venues. The trading landscape seems to be rich in opportunity.
But this abundance of choices is worrying investors who are concerned about the rise of hidden costs, increased risk, and lack of fairness. One such concern is that high-frequency traders can front-run ordinary investors, forcing prices in a disadvantageous direction. Another concern is that high-speed trading could compromise the robustness of market infrastructure. In fact, regulators are still struggling to explain the 2010 “flash crash” that caused a precipitous intraday share drop. Credit Suisse and Barclays recently paid fines for misinforming clients about how their dark pools worked.
Many high-speed traders are market makers who match purchases and sales. But that has not lessened concerns about rigged markets and unanticipated spasms because of glitches. Trading platform IEX has proposed a solution to delay trades for the benefit of institutional investors. To that end, it has applied to the SEC to become an exchange, but it may not satisfy the parameters of Regulation NMS. MIT finance professor Andrew Lo has proposed the creation of a commission to compel testimony and gather evidence to investigate market crashes, analogous to the work of the National Transportation Safety Board. Unfortunately, although well intentioned, numerous proposals may exacerbate market complexity rather than improve it.

Abstractor’s Viewpoint

The evolution of share trading in the United States may not have simplified things as intended. Greater speed and transparency may have created unintended consequences in the form of trading interruptions and rigged systems. Regulators and policymakers have been weighing in but so far to little or no avail.

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