memorandum - sec · 2013. 5. 31. · sec slide deck 5 20 13 v20c.pptx\21 may 2013\12:59 pm\3 source...

$: MEMORANDUM - SEC · 2013. 5. 31. · SEC Slide Deck 5 20 13 v20c.pptx\21 MAY 2013\12:59 PM\3 Source Tabb Group, NYSE, NASDAQ, BATS, Direct Edge, Morgan Stanley (“Dark” volume$
MEMORANDUM

TO: File No. S7-02-10 FROM: Arisa Tinaves Division of Trading and Markets

DATE: May 22, 2013 RE: Meeting with Representatives of Morgan Stanley On May 22, 2013, James Burns, David Shillman, Heather Seidel, Victoria Crane, Daniel Gray, John Roeser, David Dimitrious, Theodore Venuti, Kathleen Gross, Ilya Fradkin, Charles Sommers, Jasmin Sethi, Stephanie Mumford, Dhawal Sharma, Tyler Raimo, and Arisa Tinaves met with Andrew Silverman (Managing Director and Global Co-Head of Electronic Trading), Bill Neuberger (Managing Director and Global Co-Head of Electronic Trading), Sapna Patel (Executive Director and Head of Americas Market Structure and Liquidity Strategy) and Anthony Cicia (Managing Director and Counsel, Legal and Compliance Division) to discuss market structure issues, including the attached presentation. Attachment

Confidential Document of Morgan Stanley – For Information Purposes Only

Institutional Equity Division

Update on Equity Market Structure

May 2013

SEC Slide Deck 5 20 13 v20c.pptx\21 MAY 2013\12:59 PM\1


Agenda


2


• Public Transparency of Dark Volume Statistics

• How to Measure Market Quality?

• Trade-At is an Over-Reaction

• Addressing Aggressive Order Handling Practices

• Revisiting the Role of a Self-Regulatory Organization

• Small Exchange and Dark Pool Market Share

• Revisiting the “Block” in Today’s Electronic Market

• Summary / Suggested Actions


Public Transparency of Dark Volume Statistics No one truly knows what % of US Consolidated Volume consists of “dark” liquidity

Dark Pools

15%

Exchange Dark

5%

Exchange Lit

60%

Other TRF

20%

Estimated US “Dark” Volume 1Q 2013 % of US Consolidated Volume


3


Source Tabb Group, NYSE, NASDAQ, BATS, Direct Edge, Morgan Stanley

(“Dark” volume is based on self-reported volume by dark pools and

exchanges.)

0%

10%

20%

30%

40%

50%

Aug-0

7

Fe

b-0

8

Aug-0

8

Fe

b-0

9

Aug-0

9

Fe

b-1

0

Aug-1

0

Fe

b-1

1

Aug-1

1

Fe

b-1

2

Aug-1

2

Fe

b-1

3

TRF ex ECN TRF

TRF Market Share 10 day Moving Average

Current State

• On / off exchange volume split is easy to determine. Nearly impossible to measure

“lit” v “dark” – both forms of liquidity exist on and off exchange.

– Exchange “dark” – zero display orders. How do you categorize reserve quantity?

– TRF “dark” – dark pool, capital commitment, agency cross, retail wholesaler,

institutional electronic market maker executions

Key Considerations

• Need transparency around the composition of TRF volume – breakdown of different

forms of liquidity

– Conversely, need transparency around the “dark” portion of exchange volumes

• Post-trade execution information should be collected by SEC / FINRA and select

volume statistics made publically available in manner that does not harm customers

Recommendations

• Public breakdown of aggregate dark pool and exchange dark volume statistics,

produced by regulators (not third parties)

• Trade modifier on TRF and exchange prints to provide real-time public

transparency as to “style” of execution (e.g., “.DP”, “.ECN”, “.EXD”)

– Preserves customer anonymity when using a specific dark pool

– SEC’s 2009 Proposal on Regulation of Non-Public Trading Interest should be

revisited to facilitate this type of transparency

Source BATS Global Markets, Morgan Stanley

+6.7% pts


How to Measure Market Quality? It’s in the Eye of the Beholder


4


0

10

20

30

40

50

60

4M+ 1-4M 500K - 1M 100 - 500K 50 - 100K

<40% TRF > 40% TRF

On Exchange Spread Varies for Stocks with %TRF above 40% MS Reproduction of Exchange CEO analysis from SEC Presentation

bps

Source Morgan Stanley, TAQ – Jan 2013 data

Source Morgan Stanley, TAQ

Market Quality Factors Vary for Different Participants

• Retail: Effective / quoted spread, speed of execution

• Institutional: Transaction costs, Slippage v Arrival Price

• Market Maker: Profitability of flow / execution

• Broker: Fair & stable market, best execution, execution costs

• Exchange: Consolidated volume, market share, capture

• Overall: Continuously available liquidity / size at price,

certainty of execution

Need to balance competing interests for a healthy marketplace

Source Morgan Stanley, Reuters

0

20

40

60

80

100

0

70

140

210

280

350

<40% TRF >40% TRF Min Price Variant

Bps Spread is a Function of Stock Price 4M+ ADV stocks

MM Shares ADV bps

Stock Price

0

14

28

42

56

70

0

2

4

6

8

10

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

SPX Spread Trans Cost SPX ± E/Q Spread VIX

Sample Market Quality Measures

Bps (Spread / Transaction Costs) VIX


Trade-At is an Over-Reaction Driven by Competitive Forces Trying to Regain Market Share


5


0

5

10

15

20

25

30

0

2

4

6

8

10

12

Jan-12 Mar-12 May-12 Aug-12 Oct-12 Jan-13 Mar-13

S&P TSX Composite S&P TSX 60 VIXC

Impact of Canadian Dark Regulations Spreads have reduced … and then increased – remain correlated to volatility

Spread (bps) CVIX

Potential Implications

• Customers have always valued dark liquidity. Liquidity will

not all go back to the exchanges – naïve to think otherwise

– Retail Investors will bear increased transaction costs

– Some institutional flow will leave the market and return to

PM / traders desk

• Not all dark liquidity is the same

– Broker-dealer role is to find or be the other side for our

customer – in any size in which the customer wants to

interact

– Broker internal liquidity pools are an automation of long

established manual order handling practices

– Qualitatively different from “pinging” of external liquidity

providers by broker-dealers and exchanges in lieu of

transacting in the public market

• Real possibility exists for lower market volumes and higher

spreads

Source Morgan Stanley, Reuters, S&P

Effective Date

Key Equity Market Structure Differences: Canada Regulations must account for different US market structure

• OTC / off exchange market is nonexistent

• ~ 10% of the size of the US equity market by volume

• Earlier stage of dark liquidity evolution – < 7%; 4 dark venues

• Inter-market linkage in infancy stage

• Inter-listed market allows avoidance of Canada requirements

Maker-Taker Pricing – Is There a Better Alternative? No One has Proposed a Better Solution.

• A return to oligopolies of either exchanges or “specialists” is wrong for the market

• Market access economics should be revisited, but a competitive, transparent liquidity provision model benefits all participants


Addressing Aggressive Order Handling Practices


6


Open Issue Being Discussed Since 2008

Current State

• Order Handling & Execution Disclosure Rules have not been

updated to address technological advances and economic

driven behaviors that emerged post Reg NMS

• Broker dealers and exchanges engage in economically driven

routing of orders to external dark liquidity providers to reduce

expense – how much of TRF does this represent?

– Solicitation of order flow / actionable IOIs

– Blind pinging of external dark venues for orders otherwise

en route to the lit market, resulting in relatively low fill rates

• Customers trying to obtain full audit trail of their orders –

where routed / shown / touched and ultimately executed

– “Swing and miss” reports – no industry standard

– Detailed questionnaires about order handling practices due

to concerns about information leakage

Recommendations

• Finalize ban on actionable IOIs from 2009 SEC Proposal

• Address fiscal, external “blind pinging” practices for orders

that would otherwise interact with the lit market and

participate in public price discovery

• Mandate real-time disclosure of actual execution venue on fill

• Consider impact of outdated Rule 605 / 606 requirements on

current routing of order flow

– Require standardized reports providing an order life cycle

audit trail, not just ultimate execution or first route venue

– Mandate an exchange’s own routing broker to provide the

same transparency as all other BDs – to the end customer

• Accurate, regulator-mandated disclosure of dark liquidity

volume – for any execution venue, even if not an ATS

Broker-Dealer

SOR SOR

LP

LP

LP

LP

LP

LP

Exchange B

2%

BD routes

order to

Exchange A if

nothing done

w/ LPs

2%

Exchange

A

TRF TRF

Exchange A

BD arm routes

order to

Exchange B if

nothing done

w/ LPs

30%?

Venue of Last Resort Venue of Last Resort

Example of Fee Avoidance Strategies


Revisiting the Role of a Self-Regulatory Organization Can’t be a referee and a player at the same time!


7

• Unrealistic balancing act exists

in a world with “For-Profit”

Exchanges

– Fiduciary / profit maximizing

outcomes for shareholders

– Regulatory obligations to

maintain fair and orderly

markets


1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

2008 2009 2010 2011 2012 2013Ann

Other US Equities

Access Svcs

Exchange Revenues Nasdaq: Equities under pressure

MM USD

Current State

• All Equity Exchanges are “for-profit”

• Most traditional SRO functions are

outsourced to FINRA

• Exchanges continue to enjoy most SRO

benefits

– Assumed Immunity from Liability

– Market data tape plan revenue share

– Protected quotations in NMS

• Revenue generation sources include:

– Proprietary market data products

– Port fees

– Co-location / cross-connect

– Surveillance tools

• New market-wide obligations could result

in new fees for members / customers

Source Company Filings

Focus Areas

• For-Profit entities generally have liability

for their commercial actions

– Unlimited liability for Fraud, Gross

Negligence, Willful Misconduct

– Caps for negligent acts / omissions

should be related to likely harm

– Why should exchanges be different?

• Protected quote status should be earned –

not an entitlement

• Exchanges routing to non-exchanges –

was this really the intent in replacing ITS?

• Access fees – ports, co-location, direct

data feeds, other services – should

continue to be reviewed holistically

• Reduce number of order types – will

reduce market complexity

• Market data tape revenue pool needs to be

revisited – grossly exceeds costs


Small Exchange and Dark Pool Market Share Forced to Connect – should there be a % threshold to “earn” protected quote status?

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

CBSX (W) NYSE MKT (A) ISE (I) CHX (M) NSX (C) NASDAQ PSX (X) BATS BYX (Y) EDGA (J) NASDAQ BX (B)

Small Exchange Market Share – (13 Equity Exchanges – Required to Access All) 8 exchanges w/ <5% market share individually / <10% in total; 5 exchanges with <1% market share individually / <2.1% in total in April 2013

% of TCV

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13

CS GS GETCO BarCap MS Pool LeveL

Dark Pool Market Share – (No Requirement to Access Any) No ATSs with >2% market share in 2013

% of TCV


8 Notes

1. EDGX / EDGA data unavailable prior to exchange status conversion in July 2010 due to lack of identifier on the TRF


Source BATS Global Markets

Source Tabb Group

Sudden increases and decreases in volume should be questioned


Revisiting the “Block” in Today’s Electronic Market


9


Source NYSE (Consolidated Avg Trade Size in NYSE Listings), Nasdaq (Nasdaq Group Avg Trade Size in Nasdaq Listings), TAQ, Morgan Stanley

Recommendations

• Apply current block definition at the Parent Order level, or

• Alternatively, redefine “block” to a lower amount based on

current trade sizes

Is 10,000 shares / $200,000 still appropriate? Maybe, if you consider the Parent Order.

Current State

• Continued institutional investor interest in blocks

• Finding contra-side block size liquidity has never been

harder – reality of a fragmented, electronic and automated

environment

• Forced to “shred” orders – combination of growing use of

algorithms, Reg NMS OPR requirements and the ever

expanding number of exchanges with protected quote status

• Market participants trying to recreate block dynamics

– Prisoner’s dilemma – Everyone wants to see info, but

nobody wants to give it up

0

10

20

30

40

50

60

0

200

400

600

800

1,000

1,200

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

NYSE Nasdaq # Trades / Day

Decline of Average Trade Size

Shares Overall Mkt Trades (MMs)


Summary / Suggested Actions


10


Trade At is a Draconian Response to Addressing Aggressive Order Handling

Practices that Impact Public Price Discovery

• Limit the ability of order handlers to excessively and fiscally solicit the other side of a trade

from external liquidity providers rather than routing the order to the public market for

execution

Improve Transparency – TRF and Dark Volume Statistics and Update Order

Handling Practice Disclosures

• Provide breakdown of aggregate dark pool and exchange dark volume statistics, produced by

regulators (not third parties)

• Trade Modifier on TRF and exchange prints to provide real-time public transparency as to

“style” of execution (e.g., “.DP”, “.ECN”, “ .EXD”)

• Update Rule 605 / 606 disclosure requirements; require reporting of the entire order lifecycle,

including swings and misses, fill rates, etc.

Address For-Profit Exchanges

• Clarify / impose appropriate liability for commercial decisions

• Have exchanges earn protected status / market data revenue

• Can’t be a referee and a player at the same time! Consider Applying Current Block Definition at the Parent Order Level



11


Prior Morgan Stanley Presentations / Comment Letters on Equity Market Structure Topics

Nasdaq / BATS “Flash Orders” http://www.sec.gov/comments/sr-nasdaq-2009-043/nasdaq2009043-5.pdf 2009 Dark Pool / IOI Proposal http://www.sec.gov/comments/s7-27-09/s72709-74.pdf 2010 Market Structure Roundtable http://www.sec.gov/comments/4-602/4602-7.pdf 2010 Order Handling Practices & Disclosure http://www.sec.gov/comments/s7-02-10/s70210-328.pdf 2011 Canada Dark Liquidity Regulation http://www.iiroc.ca/Documents/2011/833b54b5-51fd-4f83-b224-17ccb0e8c6e2_en.pdf 2011

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