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Treasury Paper Outlines Market Structure Weakness and Reform

Traders Magazine Online News, October 16, 2017

John D'Antona Jr.

It was only a matter of time before the Treasury Department weighed in on equity market structure – weaknesses and reforms.

Joining the ever-growing chorus of academics, politicians and market pundits, the Treasury Department issued a bulky 231-page opus noting all the capital markets could use some improvements – not just equities. This is the second in a series of four mandated by President Trump via Executive Order in February. In a blanket call to all sectors, Treasury recommended there be better coordination among the regulatory agencies and acknowledges the need for international engagement on matters of financial regulation to ensure the competitiveness of U.S. capital markets and market participants.

In a research note shared with Traders Magazine, ITG pointed out that Treasury singled out MiFID II as a place for active engagement between the SEC and the EC, suggests that the SEC undertake a comprehensive review of the exchanges’ self-regulatory model, encourages greater collaboration between the SEC and CFTC on areas such as derivatives regulation, and calls for additional data on, and increased study of, the cash Treasuries market.

But the report didn’t stop at MiFID II – it looked deep at market structure issues and focused on two distinct areas – promoting trading in less liquid (small cap) and promoting transparency of the markets.  

Its recommendations included:

•             Small cap focus – the paper stresses the need to promote capital formation, foster more liquidity in small cap and less liquid stocks and spur more initial public offerings. Treasury recommends that corporate issuers be allowed to choose from several tick sizes for their stocks (a proposal made by Georgetown’s Jim Angel, among others), and that issuers of smaller/less liquid stocks should be able to suspend universal trading privileges (UTP), limiting trading of their stocks to only certain exchanges (a position which both Nasdaq and Bats have advocated for in the past). Importantly, non-exchange trading by brokers (e.g., ATSs, internalized blocks, etc.) would continue to provide a competitive counterweight in names for which UTP was suspended.

•             Access fees/rebates – Treasury supports creation of an exchange access fee pilot, a proposal already been put forth by the SEC’s EMSAC.  Further, Treasury suggests that if such a pilot finds that a reduction in access fees does not harm market quality, the SEC should consider whether liquidity rebates and/or payment for order flow (PFOF) could be banned – or perhaps directly passed on to brokers’ clients. While these suggestions caused a stir in the market late last week, we expect that no actions will be taken in this long-standing, hotly-debated issue until the results of an access fee pilot are known (i.e. likely two years out at earliest), if at all.

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