For questions on the note below, please contact Scott Parsons, Kevin Batteh, or Edmund Perry at (202) 547-3035.
On June 22, the House Financial Services Committee held a hearing entitled “Oversight of the SEC’s Division of Trading and Markets.” Witnesses in the hearing were:
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Haoxiang Zhu, Director, Division of Trading and Markets, Securities and Exchange Commission (SEC)
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Dr. Jessica Wachter, Chief Economist and Director, Division of Economic and Risk Analysis, SEC
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 witness testimonies and a summary of the Q&A portion of the hearing.
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.
- Republicans in the Committee were critical of the SEC for the pace and breadth or rulemakings that have come from the Commission under SEC Chairman Gary Gensler.
- The hearing focused primarily on the SEC’s recent proposals for equity market structure. Committee members questioned whether the SEC has adequately studied the way that proposals will interact with each other, and whether the SEC should stagger the implementation of the rules to consider their market impact on individual levels.
- The hearing also featured discussions on SEC proposals for Treasury market dealer registration, custody of assets, and climate change disclosures.
SUMMARY
Opening Statements and Testimony
Committee Chairman Ann Wagner (R-MO)
This is the first of many hearings we will hold with Division leadership at the SEC. Given the vast and unprecedented volume of SEC actions taken under Chair Gensler, we ensure that we are exercising proper oversight of the Commission. The SEC advanced four significant equity market structure rule proposals that will dramatically overhaul how our capital markets function.
Typically, if the SEC hopes to make meaningful reforms, it does so by advancing one targeted proposal at a time with clear and convincing evidence of the problem such a proposal is addressing. Under Chairman Gensler, the SEC has done neither of these. The SEC has instead taken a wrecking ball to all parts of our equity market structure in one fell swoop without any definitive explanations of the problems it is hoping to address. In its economic analysis, the SEC concedes numerous times that the economic impacts of these proposals are unknowable. The SEC also acknowledges that the data it is using to make these proposals is outdated and in need of reform.
Committee Ranking Member Brad Sherman (D-CA)
One issue that the SEC must address is payment for order flow (PFOF) which most investors are not even aware exists. PFOF claims to make trading free, but investors often lose more money than a commission would have been in the prices they get. The SEC is wrestling with this issue with their equity market proposals, and that is a good thing.
The securities exchanges with the biggest problems are crypto exchanges, which the SEC has correctly determined are securities exchanges. The SEC was a little slow in recognizing this problem as FTX cost investors billions of dollars, but it is finally targeting these bad actors.
I am concerned over the SEC’s proposal for swing pricing for mutual funds. We need people to invest for their retirement in mutual funds, and swing pricing will cause the opposite to happen.
Haoxiang Zhu, Director, Division of Trading and Markets, SEC
Our top rulemaking priorities at the SEC are broken into implementing Dodd-Frank mandates, strengthening Treasuries markets, and implementing new proposals on equity market structure. We are working to ensure that intermediaries that act like dealers in the Treasuries market comply with Federal securities laws for dealers. We are also working to ensure that broker-dealers are registered with FINRA with narrow exceptions.
Our proposed updates to Rule 605 will improve transparency in equity markets and ensure that customers understand their execution quality. We are also improving trading through updates to Reg NMS to narrow minimum trading and quoting increments for some stocks. The proposed order competition rule will improve competition for the handling of marketable orders from retail investors, and Reg Best Execution would create the first SEC-established rule concerning best execution.
Jessica Wachter, Chief Economist and Director, Division of Economic and Risk Analysis, SEC
High-quality economic analysis is an essential part of SEC rulemaking. It helps ensure, among other things, that decisions to propose and adopt rules are informed by the best available information about a rule’s likely economic consequences and it allows the Commission to consider a rule’s potential benefits and costs when determining if a rule is in the public interest. We work closely with all SEC divisions in designing rule proposals.
Discussion
Equity Markets
Wagner (R-MO): Is it standard for the SEC to use the same economic analysis for two separate proposals as was done in the equity market structure proposals? Could these proposals interact with each other in a way your economic analysis does not consider? Why did the SEC not hold extensive hearings on these issues before issuing the equity market structure proposals, and how can you justify the pace with which the SEC has moved with these proposals? Wachter: Economic analysis always considers the baseline of where things are today. For each of these proposals, there will be similar baselines. These proposals solve different problems, and the costs and benefits in those rules are evaluated against the baseline; Zhu: Before we proposed equity market proposals, we had extensive conversations with the public. These conversations have been ongoing and fruitful as we have considered these proposals.
Scott (D-GA): Given that even the SEC sees serious issue with Rule 605 disclosures, does the SEC believe that it has the most accurate data available to support adopting the other equity market structure proposals that are largely based on data from Rule 605 reports? Would the Commission consider delaying the other three proposals until it can use the updated Rule 605 data? Zhu: Rule 605 data has been providing valuable information to the market for twenty years, and we are attempting to add to the information provided. We believe that while Rule 605 data can be made better, it is sufficiently informative to base these other proposals off of it. Many commenters on our equity market structure proposals recommended delaying the other three proposals until we have updated Rule 605 reporting, so we will consider it.
Hill (R-AR): I have opposed the Consolidated Audit Trail (CAT) since it was first proposed by the SEC. What do you believe the largest cyber vulnerabilities of CAT are? Zhu: The protection of customer data is of the utmost importance. We have issued exemptive relief to prevent the most sensitive data is not collected by CAT. We are considering the data security of CAT, but it is not a system run by the SEC.
Meeks (D-NY): Why was the process for public engagement when developing these equity market proposals than you did with Reg NMS? Zhu: We do engage with the public as we propose rules. Since Reg NMS adoption, we have been engaged with market participants on equity market structure.
Steil (R-WI): Are the equity market structure proposals aimed at addressing concerns from the meme stock issue? Is there a conflict with the order competition rule and the best execution rule? Zhu: This event exacerbated and illuminated the problems with order competition and best execution in equity markets; Wachter: I do not believe there is a conflict between these different rules. The criticism of these rules are part of our comment file, so we will evaluate and respond to them carefully.
Nickel (D-NC): Are you concerned that auctions could actually lead to worse execution for investors if nobody bids at an auction? Wachter: We believe this rule will improve price efficiency and help capital formation.
Treasury Markets
Hill (R-AR): How many firms would become Treasury dealers simply because of their purchasing behavior based on your Treasury dealer registration proposal? Zhu: We believe it will be between twenty and thirty entities, but we have heard from some comments that it might be more.
Custody Rule
Lucas (R-OK): There has been widespread concern over the SEC’s proposal for investment advisers to custody all client assets. Did the Division of Investment Management consult with you before issuing this proposal? Wachter: We did consult with the Division.
Nunn (R-IA): Are you aware that your custody rules require the custody of client derivative contracts? Was the CFTC consulted on this rule? Why would the SEC impose a rule that raises costs for investors while providing no new benefits? Zhu: The custody rule falls under the Investment Advisors Act. We consider investor costs seriously; Wachter: My understanding is that the CFTC was consulted, but I do not know who was consulted.
Climate Disclosures
Vargas (D-CA): How does climate change impact our markets? Wachter: Many companies already disclose climate risks, but these disclosures are inconsistent and, therefore, not helpful for investors.
Casten (D-IL): Is the climate disclosure rule designed to bring consistency for investors considering climate disclosures; Wachter: Yes, and we have seen that investors want these disclosures. There is an information asymmetry in these disclosures.