Last Wednesday May 5th, Senator Kaufman proposed an amendment that would limit the amount of trading that is done off of the exchanges.
Or in Kaufman’s words, “minimize conditions under which quotations and orders are hidden or selectively disseminated.”
The Security Traders Association (STA) completely opposes the amendment. They wrote in a letter to Senators that “the impact [of the amendment] on investors will be predictable: execution costs will go up as liquidity providers pass the greater costs of doing business on to their customers.”
Of course trading off-exchange produces both positive and negative results for the market. Let’s start with the positives:
- Liquidity – Who wants to broadcast to everyone that they’re about to buy 1 million shares of some stock? Off-exchange trading encourages more trades and thus, more liquidity.
- Price improvement – A lot of times an off-exchange trade is an “internalized trade” meaning that rather than find a seller for those 1 million shares, the broker makes the trade himself at a slightly (~.001 cent) better price.
- No execution charges for the trader – If the trade is internalized, the broker doesn’t have to charge the trader an execution free.
And now the negatives:
- If the trade is internalized, there might be a bidder who’s order isn’t filled. This loss is unquantifiable. The practice could discourage market participants from trading.
- The “price improvement” is pretty minimal. The savings are spread out over so many trades, the customer himself really doesn’t save that much money. It’s just nominal savings.
- This can happen.
The worry for the market is that there would be less trading, less liquidity.
Kaufman also proposed a bill two days later, on Friday, that is a 60-day deadline by which time regulators must have figured out what happened on Thursday and must have devised a plan to prevent it from happening again.
The most significant part of Friday’s bill is probably the suggestion of pre-trade risk controls. No doubt traders, especially high frequency traders, won’t like those because at the speed they currently operate, the controls could cut significantly down on the number of trades that can be processed per day.
Regulations will definitely result faster because of Thursday’s events and the now very public fact that 60% of market volume is currently unregulated. The ongoing debate about what those regulations will entail is an interesting story we’ll continue to follow.
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