Thursday, February 13, 2020 Stamford, CT USA — Although competition and innovation are the lifeblood of U.S. financial markets, buy-side traders are frustrated by the fragmentation of equity markets caused by the launch of exchanges and venues, and support measures that would impose tougher requirements on new exchanges.

At least three new exchanges are currently in the works and, as it stands, brokers and exchanges will be required to connect to each or incur higher routing costs on Day One — even if a new exchange has limited liquidity.

With 13 exchanges already in operation, a majority of buy-side traders interviewed by Greenwich Associates oppose additional fragmentation. Only 20% are completely supportive of these additions to the exchange landscape. Another 22% of buy-side traders are supportive of new competition, but would like exchanges to achieve a minimum market share before qualifying for “protected quote status.”

“Innovators should have every right to challenge the status quo, but at the same time, it is unclear if exchanges should automatically qualify to receive flow just by virtue of the grant of an exchange medallion,” says Shane Swanson, Senior Analyst and author of Investors Take on Market Structure Issues: 2019/2020, the fourth annual edition of this comprehensive look at the most important developments in U.S. equity market structure.

New Thresholds for New Exchanges?
One way to address the fragmentation issue would be to revise the Order Protection Rule — which requires that market participants route their orders to the exchange which is displaying the best price — by making exchanges achieve a certain level of market share before they can qualify for protected quote status. Depending on where regulators set those minimums, anywhere from three to eight current exchanges would stand to lose protected status.

Regulators could take the next step and eliminate the OPR entirely. “Even in the absence of the OPR, traders will still seek out the best-priced liquidity unless they are fully prepared to justify to their bosses, their clients and their regulators why they chose to ignore it,” says Shane Swanson.

Key Issues in Market Structure: Investor Perspectives
In addition to these key issues, the new Greenwich Associates report analyzes buy- side opinions on the increase in odd-lot trading, asymmetric speed bumps, thinly traded securities, and the Transaction Fee Pilot. Among the key findings:

  • Asymmetric Speed Bumps Contrary to the current narrative, a majority of buy-side traders are supportive of asymmetric speed bumps, or rules that in times of market stress will slow down “liquidity-removing” orders, but not “liquidity-providing” orders.
  • Odd Lots With odd lots continuing to increase as a percentage of trades and volume, especially at the higher end of the pricing spectrum, buy-siders report that trading remains difficult across the spectrum
  • Transaction Fee Pilot Despite years of discussion, the buy side still does not have a consensus opinion on the Transaction Fee Pilot. However, 2020 could bring some long-awaited clarity to the issue.