HOUSE FINANCIAL SERVICES SUBCOMMITTEE HEARING
OVERVIEW
On June 27, the House Financial Services Subcommittee on Capital Markets held a hearing entitled “Solutions in Search of a Problem: Chair Gensler’s Equity Market Structure Reforms.” The witnesses in the hearing were:
- Professor Jonathan Brogaard, Professor, David Eccles School of Business at the University of Utah
- Mr. Kevin Kennedy, Executive Vice President, Head of North American Market Services, Nasdaq, on behalf of the Equity Markets Association
- Mr. Ari Rubenstein, Co-founder and Chief Executive Officer, Global Trading Systems (GTS)
- Mr. Justin Schack, Partner and Head of Market Structure, Rosenblatt Securities
- Mr. John Ramsay, Chief Market Policy Officer, IEX
Legislation considered was:
- H.R. 5273, to permit a registered investment company to omit certain fees from the calculation of Acquired Fund Fees and Expenses, and for other purposes
- H.R. 8222, the Regulation Advancement for Capital Enhancement Act of 2024, to automatically approve certain offering statements filed with the SEC under Regulation A tier 2
- H.R. 6726, the Responsible Accounting Standards Act of 2023, to require the accounting principles standard setting body to comply with the Administrative Procedure Act and the Government in the Sunshine Act, to require the head of such body to testify annually before Congress
Below is a summary of the hearing prepared by Delta Strategy Group. It includes several high-level takeaways, followed by summaries of opening statements and a summary of all proposed amendments.
Key Takeaways
The following is a summary of the main topics explored in today’s hearing. Each is discussed in further detail in the Discussion section below.
- The hearing focused on the potential implications of the four SEC market equity structure reform proposals, which include the best execution rule, order competition rule, amendments to Regulation National Market Structure (particularly concerning tick sizes), and enhanced disclosure requirements under Rule 605.
SUMMARY
Opening Statement and Testimony
Chairman Ann Wagner (R-MO)
Today’s hearing will examine equity market structure reforms put forward by the SEC Chairman Gary Gensler that will reshape American equity markets. Over the past twenty years, equity markets have changed for the better becoming more competitive, efficient, and accessible for everyday American investors. Over 100 million Americans rely on our equity markets for their financial security, stability, and retirement. Throughout Gensler’s economic analyses of the remaining proposals, the SEC explicitly admits numerous times that the economic effects of the numerous proposals are unknowable.
Ranking Member Brad Sherman (D-CA)
Investors are not protected unless they are not just getting best execution, but the most enhanced best execution. I am pleased to see the SEC’s moving in the right direction, and I hope they will work with FINRA.
Professor Jonathan Brogaard, Professor, David Eccles School of Business at the University of Utah
The SEC’s four market reform proposals seek to implement a dramatic transformation in the core infrastructure that underpins how securities are traded. Ensuring healthy and diverse retail participation represents a delicate balancing act that regulators, policymakers, and market participants have succeeded in improving overtime. Retail investors have never had it better. Retail market quality is focused around pennies and sub pennies per share. It is of the utmost importance that regulators do not enact rules that might reverse these gains.
Mr. Kevin Kennedy, Executive Vice President, Head of North American Market Services, Nasdaq, on behalf of the Equity Markets Association
Any reforms of equity market structure, no matter how well intended, must be thoughtful and rely on strong supporting data and a full understanding of the consequences that will follow. NASDAQ’s primary concerns include that they will harm the transparent, accessible, and publicly displayed lit markets. NASDAQ, in concept, supports the need to refine the minimum increment in which stocks can be quoted, but the SEC proposal misses the mark. NASDAQ is open to U.S. equities market structure based on data-driven and incremental changes.
Mr. Ari Rubenstein, Co-founder and Chief Executive Officer, Global Trading Systems (GTS)
Any regulatory changes must be data-driven. The SEC must identify market structure problems and goals then access credible data and economic analysis while ensuring that any changes, even if well-justified and intended, do not detract from the strong markets that regulators and market participants alike have worked hard to achieve. Implementing these proposals hastily could have severe consequences for U.S. capital markets. Given the health of the U.S. equity markets, the SEC should proceed thoughtfully and incrementally, focusing on empirical data to support any further regulatory action.
Mr. Justin Schack, Partner and Head of Market Structure, Rosenblatt Securities
I believe policymakers should bear in mind three principles regarding market structure. First, the interests of asset owners and issuers should be paramount when making policy. Second, end-users receive excellent outcomes in today’s market structures, but today’s efficiencies are far from guaranteed. During the early 2000s, as the market adjusted to massive regulatory change, owner transaction costs rose for a time, but eventually things got and stayed better. The growing pain period is a cautionary example of how the unintended consequences of major reforms can harm asset owners and issuers. Third, policymakers should prove clear, significant harm to market end users before adopting major reforms.
Mr. John Ramsay, Chief Market Policy Officer, IEX
The reason the U.S. equity markets are the strongest in the world is the regulators have been vigilant about keeping regulation up-to-date and relevant. The Commission has all the data, input, and rationale to move forward with the changes without delay.
Discussion
Ann Wagner (R-MO): Do you agree that the SEC should base any equity market structure reforms on the most up-to-date and relevant market data? Brogaard: Yes, I agree that we need accurate, up-to-date information to make informed decisions about what other market structure changes we may want to consider.
Ann Wagner (R-MO): Considering the tick size proposal, the best execution proposal, and the order competition proposal all reference old Rule 605 data in their economic analyzes, do you believe the new Rule 605 data will change the economic baseline of these rules? Brogaard: Yes, I do. There are several changes to the new Rule 605 data that would enhance cost benefit analysis for these other proposed rules.
Ann Wagner (R-MO): Do you believe certain elements of the SEC’s equity market reform proposals rely on unproven expectations or on how a rule might work? Schack: The volume-based transaction fee proposal envisions that things will get better for smaller brokers and exchanges competitively, and I can envision in some scenarios where the exact opposite would happen.
Frank D. Lucas (R-OK): Could you discuss why the SEC is proposing a best execution rule while FINRA and MSRB already have rules in effect? Rubenstein: I do not know why they are doing that. Best execution has been a part of fabric of the markets for a very long time, and it is FINRA and MSRB’s responsibility to enforce that.
Pete Sessions (R-TX): How can we make sure that the retail investors facing problems have fewer of these problems? Rubenstein: If we are going to mess with tick sizes, we really need to identify what the problem is, what we are trying to fix, and then be more prescriptive with the solution in a careful way that we can analyze data after.
David Scott (D-GA): How is the adoption of artificial intelligence impacting our equity markets? Ramsay: It does not seem that it has taken over trading, but there are legitimate concerns about how AI is used, that it is managed appropriately, and I think regulators need to be in tune with that.
Bill Huizenga (R-MI): Do you agree the auction process would essentially turn all retail orders into flash orders, something the SEC proposed banning in 2009? Rubenstein: I would agree that there would be a disclosure of information that markets and investors are not used to navigating, and the effects could be deleterious.
Bill Huizenga (R-MI): Do you think flash orders could be good for investors? Rubenstein: It would not be good for investors.
Bill Huizenga (R-MI): As you know, Payment for Order Flow (PFOF) information is publicly available and is subject to scrutiny by FINRA and the SEC. If there were glaring cases of misconduct or examples of market participants ignoring best execution obligations, then, presumably, we would have seen enforcement actions on that front, and my understanding is that’s not the case; Brogaard: I could not tell you of an instance where there has been an action based off PFOF.
Bill Huizenga (R-MI): Is there any research to say that PFOF is hurting the average retail investor? Brogaard: I would say the overwhelming consensus is it is positive for the investor.
Juan Vargas (D-CA): Are trades free? Kennedy: Commissions are free, I would not say trades are free. Going back to this, it is all about the spreads. The more you lower the access fee cap, the less the exchanges have to put back into the spread. Under PFOF, access fee cap will drop, we will not have the same resources to supply rebates, and economic incentives to market makers and spreads will widen. That will be the real cost to investors.
French Hill (R-AR): Do you think the Commission should prioritize updating and leveraging the best available 605 data plus getting input from market participants before moving forward with these market structure reform proposals? Brogaard: Yes, to both; Kennedy: Yes, and yes; Rubenstein: Yes, to both; Schack: I do not think that is necessary for tick size reform, and I also think the other two order competition rule and best decks should not go forward anyway; Ramsay: I do not think the 605 data is necessary to make intelligent decisions about tick size, access fees, and other aspects.
Bryan Steil (R-WI): In NASDAQ’s comment letter to the SEC, it said, “In certain cases such as access fee caps, tick sizes, and order competitions, the specific means that the SEC proposes to achieve its objectives need to be recalibrated to avoid collateral harm to markets and investors.” Can you just explain what the collateral damages are? Kennedy: The spread is the cost. If the spread changes that is where the cost to investors is. If we do not move incrementally and understand the data-driven approach, review the feedback, get feedback, we will break something.
Bryan Steil (R-WI): Does the SEC proposal put our competitive market at risk? Kennedy: In my opinion, yes. We know that markets do not like uncertainty, and corporate issuers that we deal with in and out every day.
Wiley Nickel (D-NC): Can you briefly summarize when you found in your study about whether the proposed rules necessary and would be a net positive or negative for retail investors? Brogaard: The sum takeaway is it would be a negative for investors. Right now, we have wholesalers who compete against each other and take retail orders in route with best execution and with the new best execution proposals the ability for brokers to rely on wholesalers is called into question.
Dan Meuser (R-PA): Do you think the volume-based prohibition rule would encourage competition exchange or would the rule minimize competition forcing activity off the exchange? Kennedy: Banning volume tiers is just counterintuitive to me. It will not help our markets in any way, shape, or form. If volume tiers were just to dissipate, the cost would just go up for investors, again widening the MBBO.
Dan Meuser (R-PA): Why is it important to get the tick size proposal to be withdrawn and reproposed? Brogaard: Getting the tick size right is important because it sets a lot of how the market dynamics play out. The SEC’s proposal seems to be moving too fast and too soon.