SEC Chair Gary Gensler wants to reform the investing world.
Al Drago/Bloomberg
Wall Street celebrated a report that its chief regulator is getting stymied in his effort to reform the investing world.
Bloomberg reported Thursday that Securities and Exchange Commission Chair Gary Gensler hadn’t persuaded his own agency to ban payment-for-order flow—a business arrangement in which off-exchange market makers pay retail stockbrokers to send them customer orders.
The news lifted shares of one of those market makers, Virtu Financial
(ticker: VIRT), 9% in Thursday’s market, to $23.24, even as the S&P 500 dropped nearly 1%. A brief, intraday pop was also enjoyed by the stocks of brokers who use order flow payments to subsidize their commission-free trading, including Robinhood Markets (HOOD) and Charles Schwab (SCHW).
Its unclear how many Champagne corks Wall Street should pop. Industry sources tell Barron’s they expect to learn the final fate of Gensler’s trading reforms in SEC announcements before the winter holidays.
Gensler unveiled a range of ideas for retail trading reforms on June 8, in a speech to a Piper Sandler investment conference. Along with questioning the ethics of payment-for-order-flow, Gensler said his agency was reconsidering things like today’s one-penny minimum “tick-size” for moving a stock price quote. He also said the agency might force market-makers like Virtu to compete with stock exchanges for each retail order.
The existing market structure might hurt small traders, Gensler said.
Bloomberg credited knowledgeable sources for its report that order payments would survive. But Gensler isn’t admitting defeat.
Asked about the report, an SEC spokesperson told Barron’s: “Chair Gensler said in his recent Congressional testimony that he believes that it’s appropriate to look at ways to freshen up the SEC’s rules to make our equity markets as fair, efficient, and competitive as possible for investors, particularly for retail investors.
“Staff is considering possible recommendations related to best execution; disclosure of order execution quality; the National Best Bid and Offer; minimum price increments (‘tick size’); exchange access fees and rebates; payment for order flow; and order-by-order competition.”
What can’t be questioned is that the frequently fractious Wall Street has linked arms in opposition to most of Gensler’s stock trading ideas.
A market maker like Virtu competes daily with other market makers like Citadel Securities and Jane Street Capital. These market makers are often at odds with exchanges—like Nasdaq (NDAQ), the New York Stock Exchange unit of Intercontinental Exchange (ICE), or Cboe Global Markets (CBOE)–who envy the market makers’ retail order flow. Meanwhile, retail brokers like Schwab want to shield the orders of their individual customers from the big waves made by institutional traders like BlackRock (BLK) and T. Rowe Price Group (TROW).
But all those factions gathered on Sept. 13 in a forum staged by the Securities Industry and Financial Markets Association to discuss Gensler’s June 8 ideas. With few exceptions over the five hours, each part of the industry pummeled his proposals.
Payment for order flow? Vanguard Group’s head of trading James Martielli noted that his firm believes order payments can create a conflict in a broker’s duty to get the best trade execution for their client. Instead of banning such payments, Vanguard believes any conflict should be addressed by requiring standardized disclosures on each brokers’ execution performance.
Schwab Vice President Jeffrey Starr said the payments don’t affect his firm’s order-routing, or the execution quality its retail customers receive. Such payments pay for trading-talk programming of the online network tastytrade, said the North America chief executive of tastytrade parent IG Group ( IGG . London) JJ Kinahan — not to mention the commission-free trading offered by most retail brokers.
“Retail clients …there is one thing that they absolutely hate more than anything else in the world,” said Kinahan, “and that’s the word ‘commission.’”
Tick size reform? Change would be a good thing, said the NYSE’s chief operating officer Michael Blaugrund. Exchanges are constrained to quote in increments no narrower than a penny, he noted, while market makers like Virtu can attract orders by executing trades within the penny spread between the bid and offer quote. Some exchanges now offer sub-penny trades to retail traders, but they can’t display those quotes publicly.
“It’s like holding a golf tournament and letting some of the golfers use a full set of clubs and asking other golfers to use a putter and a driver,” said Blaugrund, whose exchange would like to see a single regime for all venues.
“I don’t believe we should do a one size fits all approach across the market,” countered Mehmet Kinak, who heads systematic trading at T. Rowe Price. His fund firm would like to see quote increments narrow for the 70 or 80 highly liquid stocks that are tick-constrained, but liquidity would vanish for most stocks if quote increments became too small.
BlackRock’s head of electronic trading, Hubert DeJesus, agreed. “When you increase the number of price points,” he said, “then you’re essentially fragmenting the quotes and you’re essentially dispersing liquidity across them multiple prices.”
An order-by-order auction? Such a mechanism would complicate trading, without benefiting institutional traders, said BlackRock’s DeJesus. Order-by-order competition wouldn’t increase liquidity, said T. Rowe’s Kinak, because institutions are generally looking to take liquidity, not supply it to retail traders. “I’m not so sure we want to interact with retail all the time,” said Kinak, “Or can, for that matter.”
Virtu chief executive Doug Cifu applauded the views of BlackRock and T. Rowe. “We have two of the largest buy side institutions in the United States, saying that this isn’t a problem,” Cifu said. Retail brokers require market makers like Virtu to provide liquidity and improved pricing on all of the thousands of stocks out there, said the Virtu chief.
The market makers’ price improvement is real, vouched Schwab’s Starr. He said his firm’s customers saved some $7 billion on their trading last year, thanks to market makers’ pricing. Even in dangerously volatile stocks like Bed Bath & Beyond (BBBY), the market makers maintained price performance, said Starr.
“Changes to market structure could put that at risk,” warned the Schwab executive. “And that’s why we feel as strongly as we do about really being careful and cautious here.”
Write to Bill Alpert at william.alpert@barrons.com
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