US Treasury Report on the Financial System:

A First Take on Its Impact on the US Equities Market

V15-040 | October 2017 | www.tabbgroup.com

US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Introduction
The US Treasury Department issued last week a report titled, A Financial System That Creates Economic
Opportunities Capital Markets. This extensive report reviews the US financial markets across capital access,
equity market structure, the US Treasury market, corporate bond liquidity, securitization, derivatives, financial
markets utilities, the regulatory structure and process, and the international aspects of financial markets regulation.
In other words, the US Treasury just dropped a very extensive report opining on virtually all aspects of the US
financial markets.

While the report is in-depth and extensive, anyone

involved and/or interested in the institutional capital
markets needs to take the time to read it directly. To
help the industry digest the report, however, I have
attempted to summarize the US Treasurys
recommendations and place them in context, and to
explain the impact of the Treasurys proposals.
Before I get started, however, it is important to point
out that the US Treasury does not directly regulate
financial markets. As such, I am not sure how much
weight these recommendations will have. Certainly,
the opinion of the US Treasury has influence more
influence than any firm, research provider, university,
industry consortium, or even a think tank. But the US
Treasury does not have oversight of the US regulators
or the Federal Reserve, so at the end of the day, the
influence these findings and recommendations will
have is unclear.
Given that the report is 220 pages long, I will break out
my analysis based on its sections. This first area that I
will write on will be the US Equities market and market
structure.
This piece is organized by the categories outlined in
the US Equities Market Structure chapter within the
Treasury study. This report will outline the challenge,
highlight the US Treasurys recommendations (using
direct quote, and will subsequently offer my insight
into the solutions origins as well as my comments on
their impact and validity.
I would also like to thank the US Treasury for using one
of my research reports as a reference in the study:
Regulation NMS Part I: Loved or Loathed and Why
Many Want It to Die.

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 2
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Fragmentation of Liquidity and Promoting

Liquidity in Less Liquid Stocks
Problem
Less liquid stocks trade less frequently. With 13 equities exchanges, 30 equities ATSs, and 15 options
exchanges, liquidity can be spread across a wide array of platforms and finding the other side of the trade can
be problematic.

US Treasury Report Recommendations (direct quote)

Treasury recommends exploring policies that would consolidate liquidity for less-liquid stocks on a
smaller number of trading venues. Consolidating trading to fewer venues would simplify the process of
making markets in those stocks and thereby encourage more market makers to provide more liquidity in
those issues.

Treasury recommends that issuers of less-liquid stocks, in consultation with their underwriter and
listing exchange, be permitted to partially or fully suspend UTP for their securities and select the
exchanges and venues upon which their securities will trade. ...

Accordingly, the SEC should consider amending Regulation NMS to allow issuers of less-liquid stocks
to choose to have their stock trade only on a smaller number of venues until liquidity in the stock
reaches a minimum threshold. To maintain a basic level of competition for execution, broker-
internalization should remain as a trading option for all stocks.

trade for less liquid securities easier. While the study

Solution
The US Treasury recommends eliminating the ability
to trade less liquid stocks across all exchanges and
to concentrate liquidity for less liquid stocks in a more
limited group of exchanges. It also recommends that
issuers, along with their advisors, determine which
exchanges these securities trade on. It does not
recommend banning internalization for these stocks.
Impact
The impact of this recommendation would be to
consolidate liquidity for less liquid securities at, most
likely, the primary exchange and maybe one or two
others. This would make finding the other side of the
doesnt say that trading privileges should be confined
to only one venue, this is a bit more interesting than
the Bats/Nasdaq proposal to limit trading to the
listing venue and may actually be a very good
compromise between competition and consolidation.
By providing the ability to choose multiple venues on
which to trade a stock while limiting fragmentation,
we wont have a monopoly by an exchange that
creates a poor trading environment, or Universal
Trading Privileges (UTP) which can scatter liquidity
across 40 or more trading venues.
This recommendation, however, does not ban broker
internalization of these stocks. This will allow

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 3
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market
wholesalers to provide added
improvement/liquidity) for these stocks.
value
There is however some ambiguity in this section over
ATS trading of less liquid stocks. Since many ATSs
are offshoots of broker internalization facilities, will
ATSs be allowed to trade these securities or will the
trading be confined to only registered equity
exchanges, or will issuers get to pick and choose the
ATSs where these securities trade?
Provenance
The idea to limit trading rights for less liquid securities
was originally proposed by the Bats exchange and
was subsequently endorsed by Nasdaq.
discussion about issuer choice was championed by
The Equity Dealers Association.
Bottom Line
For me, the overall questions are: first, where will the
lines be drawn between universal trading and the
more confined trading contained within this proposal?
Second, given that internalization will not be banned,
what will the status be of ATS trading in these chosen
names? And third, if all of these stocks can be traded
on ATSs but not at all exchanges, will this rule be
deemed discriminatory?
Presuming that these lines are drawn at the
appropriate places, and we can determine a way to
manage/limit the ATS trading of these names (so
liquidity across ATSs is concentrated as well), I
believe this is a very good recommendation that will
help the trading of less liquid securities.
2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 4
October 2017
(price
Constituent
Benefits/Challenges
Self-directed Investors: Positive. Liquidity
should concentrate, and order competition should
create a tighter market for these less liquid equities.
Institutional Investors: Positive. Liquidity
should concentrate and order competition should
increase, creating a tighter market for these less
liquid equities.
Brokers: Positive. Brokers should have an easier
time finding liquidity, and investors should have a
better outcome with a more liquid and tighter market.
The This may, however, cause greater competition and
put downward pressure on commissions; but that is
a second- or third-level outcome, which is harder to
forecast.
Exchanges: Positive for listing exchanges; negative
for secondary exchanges. This will be positive for
listing venues, given that they will almost universally
be among the chosen exchanges. Secondary
exchanges will have a more challenging time, with
larger exchanges experiencing a neutral to positive
outcome, as they would most likely be a secondary
choice; however, smaller exchanges will experience a
negative outcome, since they most likely wont be
selected as a trading venue.
ATSs: Mixed. If less liquid products can trade on
ATSs, this will be neutral; if they cant, then negative.
Wholesalers/Market Makers: Neutral to
negative. A tighter market for less liquid issues means
less market making profitability. If spreads stay
consistent, then neutral. That said, with a reduction
of trading venues, market maker liquidity should be
more concentrated enabling market makers to
increase their size commitment while concurrently
reducing their risk in trading less liquid names.
Dynamic Tick Sizes
Problem
The US Equities market has a single tick size of 1 cent (for stocks trading above $1.00). This is true for low
priced stocks such as GSAT (Globalstar) trading at $1.64 or high-priced stocks such as BRK-A (Berkshire
Hathaway) trading on Friday October 6, 2017 at $279,360 a share. This creates difficulties in trading less liquid
and higher-priced names (when tick sizes are greater than the minimum) as the cost to outbid another order
in a one cent tick increment is negligible. This also means that investors are paying too much to trade highly
liquid lower-priced names, where the minimum one cent tick-size spread is artificially wide.

US Treasury Report Recommendations (direct quote)

Tick size is another area where one-size-fits-all changes may need to be better tailored to individual
stocks. Treasury recommends that the SEC evaluate allowing issuers, in consultation with their listing
exchange, to determine the tick size for trading of their stock across all exchanges. Such a change would
borrow a good idea from the futures markets. ...

While different tick sizes for different stocks would increase the complexity of the market, this could be
managed by limiting the potential choices to a small number of standard options, e.g., 10 cents, 5 cents,
1 cent, or cent per share. Similar to the tick size pilot, exceptions could also be made for retail orders
as appropriate.

tick size for less liquid securities, the proposals if

Solution
To ensure that orders do not get picked off and/or
limit orders are better protected from being
intermediated, the US Treasury is recommending a
more flexible tick-size regime. This will enable less
liquid stocks to have a wider tick, but also lower
priced and more active stocks to have a narrower tick
size (1/2 cent).
Impact
The more flexible tick size will create more natural
incentives for providing liquidity. Currently, many
exchanges incentivize liquidity by providing a rebate
to liquidity providers (makers in maker-taker markets
and takers in taker-maker markets). By widening the
enacted, should create greater incentives to provide
liquidity for these stocks and fewer incentives for
providing liquidity for more actively traded lower-
priced stocks (as 1 cent is a larger percentage of the
proceeds for a $10 stock than a $100 stock).
This proposal will also drive more liquidity to pool on
the bid/offer of wider tick-size stocks, as there will be
fewer tick sizes and those ticks will be wider. This will
increase the cost to outbid a 10-cent spread stock by
10 times over the current 1 cent (or nickel for stocks
included in the SEC Tick-Size Pilot). This should force
traders to think more carefully about outbidding limit
orders in less liquid stocks, as they will need to pay
more than 1 cent to step in front of a limit order.
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Provenance non-SEC Tick Size Pilot stocks) has become almost

pointless.
This idea was initially proposed by David Weld IV, and
incorporated into the JOBS Act. However, when this
was proposed by the SEC, the regulator only widened Constituent
Benefits/Challenges
the tick size by 5 cents. The SECs Tick Size Pilot also
incorporated a number of other proposals into the
rule. These additional aspects of the pilot Self-directed Investors: Neutral to negative.
complicated the program. In addition, some Wider ticks mean higher transaction costs for less
proponents of the widened tick-size opined that the liquid and higher-priced stocks. Given that the
SEC didnt go far enough in creating the appropriate average US Equity share price is above $60, this
incentives to provide liquidity, develop research, and could impact the majority of traded stocks. On the
stimulate IPOs, which were the original drivers for the other hand, limit orders should become more
SEC Tick Size Pilot. Subsequent to the JOBS Act, the effective; however, most self-directed investors use
Equity Dealers Association proposed an additional market orders.
plan for a flexible tick size regime. Institutional Investors: Mixed. Wider ticks

Bottom Line mean higher transaction costs; however, greater

displayed liquidity means trade sizes will be larger,
This proposal would reduce maker-taker rebates in
and implementation costs may be lower. Firms with
more liquid and lower-priced stocks while realigning
better execution technologies may do worse, given
incentives to provide more liquidity for less liquid
wider ticks could neutralize the advantage of
names. It will facilitate less intermediation in the
investments in technology and trading skills.
trading of more liquid and lower priced stocks, while
Brokers: Positive. Wider ticks mean greater
creating greater incentives to provide liquidity for
incentives for providing liquidity.
higher-priced and less liquid stocks. The downside of
this plan, however will be to widen spreads for these Exchanges: Negative. Wider tick sizes mean that

higher priced and less liquid stocks causing investors trading will be more expensive and the savings from

to pay more for liquidity in these names. trading in the dark will be greater.

ATSs: Positive. Wider ticks mean that there will be

This, in my opinion, is a good trade off, especially for more saved when trading at the midpoint in the dark.
institutional investors, which represent the majority of Wholesalers/Market Makers: Positive. Wider
individual investors. It will, however, make it more ticks mean greater incentives for providing liquidity,
expensive for self-directed investors trading less and given there are calls not to eliminate price
liquid and higher priced stocks. While it may be more improvement, a wider tick equates to more
expensive to trade less liquid stocks, it will also allow opportunities for price improvement.
investors to more effectively place limit orders, which
under the current penny spread regime (for many

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 6
Maker-Taker and Payment for Order Flow
Problem
Maker-taker rebates and payment for order flow create the potential for a conflict of interest. Given exchanges
pay rebates to traders using some order types and charge higher fees to others who select other order types,
there can be a conflict of interest between the incentive provided to the broker and clients best interests. The
same can be said for payment for order flow programs: Can best execution be provided if a wholesaler pays a
broker for its order flow?

US Treasury Report Recommendations (direct quote)

Treasury is concerned that maker-taker markets and payment for order flow may create misaligned
incentives for broker-dealers. Accordingly, Treasury recommends that the SEC consider rules to mitigate
the potential conflicts of interest that arise due to these compensation arrangements.

First, Treasury recommends that the SEC require additional disclosures regarding these arrangements.
The proposed rule changes would require broker-dealers to provide institutional customers with specific
disclosures related to the routing and execution of their orders, and also require broker-dealers to make
aggregated information about their handling of customers institutional orders publicly available. The
proposed rule changes would also require that retail customers receive additional information about their
orders, including the disclosure of the net aggregate amount of any payment for order flow received,
payment from any profit-sharing relationship received, transaction fees paid, and transaction rebates
received by a broker-dealer from certain venues; and descriptions of any terms of payment for order flow
arrangements and profit-sharing relationships. ...

If the study showed that the reduction in fees did not have material negative effects on market quality,
the SEC should consider restricting the use of rebates and payment for order flow arrangements. The
SEC could also consider whether it should require broker-dealers acting as agents to refund rebates and
payments for order flow to their customers. If payments went directly to customers rather than
intermediaries, incentives would be more appropriately aligned. Rebates are another area where tailoring
to the situations of more- and less-active stocks may be appropriate. While the issues affecting the
market for less-liquid stocks are many, and a potential rebate is a small part of the equation, Treasury is
hesitant to recommend any course of action that could worsen liquidity for less actively traded stocks.
Accordingly, Treasury recommends that the SEC exempt less liquid stocks from the restrictions on
maker-taker rebates and payment for order flow if such exemptions promote greater market making.
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Solution Passing back fees/rebates to clients, has been

discussed by many industry participants, however it
The only solution the US Treasury recommends is
is generally met with resistance by institutional
further disclosure.
investors, which are challenged by the workflow,

Impact technology and fairness issues presented by this

proposal.
The US Treasury recommends disclosure and
discovery in its proposals for maker-taker rebates and
Bottom Line
payment for order flow. Treasury is requesting greater
The US Treasury doesnt seem to know what to do
order routing and payment for order flow disclosures
here. By recommending greater transparency and
and transparency; however, it does not recommend
disclosures, it seems the Treasury would like to study
any immediate market structure change.
this issuer further, however, the US Treasury is not
recommending the complete transparency that would
The Treasury also discussed passing back
be needed to answer this question completely, it is
rebates/charges to investors. This would eliminate
only recommending aggregated broker transparency.
any conflict; however, it could be very problematic for
A lot of insight can fall into the cracks with average
exchanges and brokers, as the current exchange
and aggregated information.
tiering plans only allow the exact pricing to be known
once the broker has hit a price tier, which tends to be
While I agree that greater disclosure is needed for
toward or at the end of the month. This proposal
order routing and payment for order flow, I am not
would also be problematic for buy-side firms, as it
sure either the SEC or the US Treasury has gone far
would force the buy-side to allocate commissions,
enough. To properly analyze broker routing and venue
fees, and rebates on an ex-post facto basis once the
performance, granular data, more fine-grained
broker has hit its final exchange pricing tiers and has
timestamp values and proper time synchronization
passed that information back to its clients.
standards, down to the millisecond at the least
(microsecond standardization would be preferable)
While the US Treasury recommends monitoring
are needed. Analyzing aggregated routing is good, but
routing and payment for order flow arrangements, it
it wont be at sufficient granularity to fully enable
doesnt want any future restrictions to impact less
investors to work with their brokers in truly optimizing
liquid securities.
their algorithmic routing. While the Consolidated

Provenance Audit Trail (CAT) plan forces exchanges to have

synchronized clocks down to 100 microseconds,
Without full detail on the disclosure and transparency
ATSs and routing brokers are not held to that
requests, the disclosure/transparency proposals
standard. That said, lets not have perfect be the
appear to fall in line with the anticipated SEC order
enemy of good. This proposal is a good place to start.
routing, and payment for order flow proposals that
emanated from the SIFMA/ICI/SEC EMSAC
It is also very good that the US Treasury didnt
recommendations, known in the industry as
recommend market structure changes, to solve
enhanced 605/606 reporting guidelines.
these challenges. Given current market structure
complexity, making any specific changes would more

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 8
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market
likely hurt investors rather than help them. The only
way to solve this issue is through very granular
analysis. This is challenging given timestamp field
length (many brokers dont capture time scales below
milliseconds and some dont capture anything less
than one second increments), synchronization issues,
and the evolving understanding of routing best
practices. At this time, given our current state of the
art, analysis is much better than rule-making. We
should be measuring before we mandate change, and
that seems to be the direction that the US Treasury
is taking.
This is a good tradeoff, especially for institutional
investors, which represent the majority of overall
investors.
Constituent
Benefits/Challenges
Self-directed Investors: Neutral to positive.
The move would give self-directed investors and their
brokers better routing information.
Institutional Investors: Neutral to positive. It
would give institutional investors better routing
information, but it is not sufficient enough to allow
investors to work with brokers to tailor their
2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 9
October 2017
algorithmic trading. We would need much more
granular information for this to occur.
Brokers: Negative. It will cost brokers money to
carry out this exercise, and while it should provide a
better outcome for investors, it will put pressure on
market making activities and create greater scrutiny
on brokers best execution results.
Exchanges: Mixed. The rule would provide greater
oversight into the equity order routing practice. This
should put pressure on brokers, market makers and
ATSs, which will funnel more flow into equity
exchanges. On the opposite side, the payment for
order flow process for the US Options market may
come under pressure, as PFOF is at the core of many
options exchanges execution strategies.
ATSs: Neutral to negative. The rule would provide
greater disclosure on equity execution and may make
ATSs more competitive.
Wholesalers/Market Makers: Mixed. This
recommendation will provide investors with greater
transparency on order routing and payment for order
flow programs, making it harder for wholesalers to
secure order flow. However, it should be positive for
market makers that do not engage in payment for
order flow practices, given more flow will be
routed/traded on-exchange.
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Market Data
Problem
Order protection and best execution rules have two major repercussions: First, they force brokers to connect
to exchanges even if they have virtually no market share, and second, they allow the exchanges to charge
almost any price for their market data, exchange connections and colocation space, which has become almost
mandatory for any broker wishing to provide meaningful automated execution tools (algorithms).

US Treasury Report Recommendations (direct quote)

Treasury recommends that the SEC and FINRA issue guidance or rules clarifying that broker/dealers
may satisfy their best execution obligations by relying on SIP data rather than proprietary data feeds if
the broker-dealer does not otherwise subscribe to or use those proprietary data feeds.

The SEC has the authority under the Exchange Act to determine whether the fees charged by an
exclusive processor for market information are fair and reasonable, not unreasonably discriminatory,
and an equitable allocation of reasonable fees among persons who use the data. The SEC should
consider these factors when determining whether to approve SRO rule changes that set data fees. ...

To foster competition and innovation in the market for SIP data, the SEC should also consider
amending Regulation NMS as necessary to enable competing consolidators to provide an alternative to
the SIPs. ...

The SEC should consider amending the Order Protection Rule to give protected quote status only to
registered national securities exchanges that offer meaningful liquidity and opportunities for price
improvement. Furthermore, protected quote status should go to exchanges only if the cost of connecting
to the market offsets the burden in market complexity and data costs that connecting would impose on
broker-dealers and other market participants. Accordingly, the SEC should consider amending the Order
Protection Rule to withdraw protected quote status for orders on any exchange that do not meet a
minimum liquidity threshold, measured as a percentage of the average daily trading volume executed on
the particular exchange versus the volume of all such securities transactions executed on all exchanges.

Accordingly, the SEC should consider proposing that any newly registered national securities exchange
also receive the benefit of protected order status for some period of time to allow the new exchange an
opportunity to thrive. ...

... The SEC should also consider issuing interpretive guidance concerning whether broker-dealers best
execution obligations could be satisfied without checking the best bid or offer available on marginal
exchanges.

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 10
Solution
The US Treasury has recommended a number of
solutions to this challenge. First, the Treasury
recommends that the SEC more thoroughly vet
exchange market data pricing schemes. Second, it
embraces the philosophy of competing Securities
Industry Processors (SIPs), which will give many
brokers the ability to bypass more expensive direct
feeds. And third, it recommends eliminating order
protection (and best execution obligations) for
exchanges with negligible market share, with an
exception for newly authorized exchanges.
The US Treasury packed a significant amount of
change into this section on market data, including:
Rely on the SIP instead of direct feeds for
best execution routing (except if you use
direct feeds within your firm).
The SEC should ensure that market data
fees are reasonable.
Create a facility for SIPs to compete.
Eliminate order protection for exchanges
with de minimis market share.
Enable brokers to consider the cost of
connection in regard to best execution
obligations in determining if it is prudent to
connect to a trading venue.
Provide order protection support for newly
authorized exchanges during a window of
time when they can gather the requisite
market share cutoff. If newly authorized
exchanges can meet the threshold, then the
venue should be granted order protection
status; if not, order protection should be
waved.
Impact
The impact of the market data section in the Treasury
report is very significant. While the initial best
execution guidelines to use the SIP over direct feeds,
except when firms use direct feeds for their own
trading, is almost exactly the guidance that FINRA
provided in November 2015, and the idea that the
SEC should validate market data pricing is just a shot
across the bow of the SEC to do its job (or should I
say, do the job the industry expects it to do). The US
Treasury has gone much further, as it proposes the
idea of competing SIPs, eliminating order protection
for exchanges with marginal market share, allowing
brokers to add in the cost of market data and
connectivity in determining where they connect to,
and allowing brokers to fulfill their best execution
obligations even if the best price shows up in an
exchange with de minimis market share.
Provenance
The ideas proposed in this section come from a
number of places. The ideas about the SIP and direct
feeds come directly out of the FINRA Best Execution
Guidance, issued November 2015, footnote 12. The
proposal for competing SIPs was, I believe, initiated
by both Bret Redfern at JP Morgan and Adam Nunes
of Hudson River Trading. And the ideas on an order
protection carve out for exchanges with de minimis
market share have been discussed over time.
Bottom Line
Exchanges will not like this section. While the
exchanges may enjoy less competition, since the
three major exchange firms control all but one
market, the exchanges that get shuttered will mostly
be their own (which may be a positive, as it will
reduce cost). Where exchanges could be hurt is in the
section on competing SIPs, as, depending upon how
these competing SIPs are developed and configured,
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market
SIP competition will undercut the exchanges data,
colocation and market access franchises.
The act of developing competing SIPs should reduce
the latency embedded in SIP transport; however,
whether the SIPs have depth-of-book data will be the
most important aspect determining the impact of this
proposal. If the competing SIPs include depth-of-
book data, it will provide a good alternative to direct
feeds and could impact the market for market data
significantly. If the SIPs, as they do today, do not have
depth of book, the competing SIPs will siphon some
market data away from direct feeds; however, market
makers/brokers that want the highest performing
algorithms will still need to buy direct feeds from the
exchanges.
These recommendations will make it harder for
smaller exchanges to remain solvent, given these
proposals allow brokers to bypass exchanges with
non-meaningful market share. This is, of course,
dependent upon where the line between meaningful
and non-meaningful is drawn.
This section, however, is very pro-broker. It allows
brokers to include the cost of connection and market
data in determining where they connect and how they
obtain data. It will also give the broker more leeway
in complying with best execution obligations.
This section is less friendly to investors. While it will
reduce complexity, it will become more important for
institutional investors to use a third-party, non-broker
analytics provider to analyze brokers execution
quality given that a broker can decide to turn off a
smaller exchange and the brokers will have more
leeway in determining where they connect. Without a
third party analyzing a brokers execution quality, it
will be very difficult to validate whether a broker has
2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 12
October 2017
truly obtained the best price, or only obtained the best
price from the venues that it connects with.
While this section is very broker-friendly, by and large,
I believe the US Treasury recommendations are on
target, given the consolidation of the exchange
community into three major players and their
influence in the price and provisioning of market data.
This should make market data cheaper, force
exchanges to compete more actively, and, while it
may be more difficult for smaller exchanges to gain
traction and force institutional investors to buy more
enhanced transaction cost analytics, it will reduce the
cost of market data, connectivity and trading for
brokers and, hence, investors.
Constituent
Benefits/Challenges
Self-directed Investors: Neutral to negative.
Less exchange competition may mean wider prices;
however, the exchanges that will be excluded will
most likely be smaller exchanges, which will have less
impact on individuals trading practices.
Institutional Investors: Neutral to negative.
Brokers will not need to connect to all exchanges and
brokers wont be held to their best execution
mandates for quotes that occur on these exchanges.
Institutional investors will need to measure best
execution more carefully, which will, in the longer run,
enable institutional investors to execute much more
effectively. This proposal would be more positive to
institutional investors if institutional investors
acquired direct feed data; they usually dont, and the
data that many of these firms use for trading is paid
for by brokers, so the cost benefit will mostly be
neutral.
Brokers: Positive. SIP competition will mean that
there will be less expensive data alternatives
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

available, and those alternatives will be faster. Also, allow ATSs to transition from high-priced direct feeds
brokers will not have to connect to less liquid to a lower-cost, lower latency SIP feed. While this
exchanges and pay their data fees. would allow ATSs to reduce their cost structure, it

Exchanges: Negative. It will cause smaller price- should not impact their market share.

time markets to close, and by providing a competitive Wholesalers/Market Makers: Neutral to

SIP, it will create greater market data competition,
which will force exchanges to invest, charge less
money, and allow less robust users to switch from
more expensive direct feeds to lower cost SIP
alternatives.
positive. While some market makers may not need to
connect to smaller venues, many do not connect now.
Unless the competing SIP products have depth of
book, wholesalers and market makers will most likely
need to use direct feeds.

ATSs: Neutral to positive. These proposals should

reduce the cost of ATSs market data, as they will not
need to use direct feeds to price their trades, and

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 13
Reducing Complexity in Equity Markets
Problem
The exchanges have developed a series of order types and processing flags that make negotiating the
exchanges very complicated. While conceptually there are a limited number of order types marketable, non-
marketable, reserve and end-of-day auction in reality there are dozens of order types at each exchange with
dozens of processing flags that can increase the number of exchange processing instructions into the
thousands (according to the US Treasury report).

US Treasury Report Recommendations (direct quote)

Because market complexity is exacerbated by the proliferation of order types, Treasury recommends
that the SEC review whether exchanges and ATSs should harmonize their order types and make
recommendations as appropriate. The SEC should consider whether particular order types sustain
sufficient volume to merit continuation.

Solution Bottom Line

To review order types with the view on simplifying
them.
Impact
There will be little if any impact from this section.
Provenance
This has been championed by many over a long
period of time. The firm that has built a business
around this simplicity has been IEX; however, given
some of its newer order types, it also has moved
significantly away from being a truly simple trading
platform.
Nothing will happen here. It is in the SECs purview to
approve order types, and many of the order types and
processing flags are built in response to SEC rules.
Unless the market structure was more significantly
simplified, or consolidated, it will be very difficult for
exchanges and/or the SEC to reduce this complexity.
Constituent
Benefits/Challenges
The benefits and challenges to all market participants
is neutral, as the proposal is for further review only.
Regulation ATS
Problem
There are more than 30 ATSs. Each and every platform operates under its own rules. Under Reg ATS, the
platforms rules sets are confidential. This makes it very difficult for users of these platforms to fully understand
how they operate. This causes confusion and in some circumstances bad practices. A number of brokers were
fined because of incorrect/improper disclosures and/or trading practices.

US Treasury Report Recommendations (direct quote)

Treasury agrees with the SECs goals of amending Regulation ATS to increase public information about
NMS Stock ATSs. Additional transparency regarding an NMS Stock ATSs operations will allow
participants and investors to make more informed decisions about whether to execute transactions on
the venue.

Solution Bottom Line

To review Regulation ATS to increase disclosure of The SEC is moving forward with greater
how ATSs operate and to provide additional transparency and disclosures for ATSs. In addition,
transparency on orders placed and executed within platforms such as Babblefish Analytics,
ATSs. LiquidMetrix, and Trade Informatics will push this
transparency even further. While this level of
Impact analytics is still in the formative stage, we believe it
This is in alignment with the direction of the SECs will become increasingly a standard set of best
current direction. execution measurements.

Provenance Constituent
Industry participants have been calling for this for
many years. TABB Group, as early as 2007, called
Benefits/Challenges
for greater ATS transparency when we asked the Self-directed Investors: Neutral. Investors
SEC for ATS volume statistics (and were told that rarely read these disclosures, and ATSs generally
Form ATS was confidential) in an early attempt to are not used by self-directed investors.
develop our Equities LiquidityMatrix. Since then Institutional Investors: Positive. The addition
there have been other firms, including Rosenblatt, disclosure will help institutional investors better
FIX Protocol.org, TABB Groups Clarity platform understand how these platforms operate. More
and Healthy Markets, that have advanced the call rigorous reporting and transparency will help the
for greater disclosures and transparency on ATS buy side better work with brokers to improve
operations and executions. execution quality.
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

Brokers: Neutral to negative, with a positive Wholesalers/Market Makers: Negative.

twist. The greater transparency will be expensive to
produce and continuously maintain, and the
increased transparency will shed light on poor
performers; however, it will reallocate flow from the
poor performers to the better performers.
Greater transparency will mean a more competitive
market with less volatility and performance
opportunity. The greater transparency should lower
the boundaries between the more and less
sophisticated operators. This is one of the ways

Exchanges: Neutral. This should push flow from that wholesalers and market makers generate

the poor performing exchanges to the better revenue.

exchange venues.

ATSs: Mixed. Greater discloser will help the ATSs

that better supervise, manage and control their
trading activity and hurt the ones that dont.

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 16
Conclusion
The US Treasury report on the US financial system has an extensive set of recommendations to improve the US
equity markets. The Treasury analyzed a number of very complex and thorny issues and developed thoughtful
positions based upon a few strategic assumptions namely, a focus on improving the ability to issue equity
securities, reducing the complexity with our existing framework, and walking the razors edge on increasing
competition where it is currently lacking, and reducing competition where it has led to extreme complexity and
poor outcomes for investors.

In developing these recommendations, it appears trading. Meanwhile, the market data

that the Treasury reviewed a wide array of research
and entertained discussions with a number of
industry players.
The set of recommendations does not seem to be
one sided. There are positive and negative
externalities that accompany the complete set of
recommendations, so it does not seem to
disenfranchise any one constituency, providing both
benefits and challenges to each group.
recommendations, depending how they are
implemented, could make the pricing of market data
more competitive, which could threaten exchanges
increasingly important data business.
In my view these recommendations would be a
positive addition to our markets, depending upon
how they were written and implemented. Even the
best proposal implemented incorrectly could cause
problems.

My perception of the most advantaged are
institutional investors, followed by brokers and self-
directed investors; while the most disenfranchised
group is the exchanges, followed by wholesalers and
market makers. The largest challenges to exchanges
stem from the dynamic tick-size and market data
recommendations. The dynamic tick-size
recommendations widen the tick size, making it
more expensive to trade, and hence incentivize less
While these proposals are beneficial, it will be
interesting to see where they will go, given the US
Treasury does not have direct regulatory authority
over the SEC, FINRA, brokers, investors, exchanges,
ATSs, or wholesalers/market makers at least in the
US Equity markets. That said, the US Treasury has
thrown down the gauntlet, challenging the industry
to start a dialog to improve our execution
infrastructure.

Exhibit 1
Summary of US Treasury Study on the Equities Market Constituents

Fragmentation Dynamic Tick Sizes Make/Take-PFOF Market Data Reducing Complexity Regulation ATS Average Score

5 2 4 2 3 3 3.17
Self Directed Investors

5 3 4 2 3 5 3.67
Institutional Investors

5 5 1 5 3 2 3.50
Brokers

3 1 3 1 3 3 2.33
Exchanges

2 5 2 4 3 3 3.17
ATS
Wholesalers/Market Makers 2 5 3 4 3 1 3.00

3.67 3.50 2.83 3.00 3.00 2.83

Average Score
Scale: 1) Negative, 2) Neutral to negative, 3) Mixed/neutral, 4) Neutral to Positive, 5) Positive
Source: TABB Group

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission 17
 About
TABB Group
TABB Group is the international research and consulting firm focused exclusively on capital markets, founded
on the interview-based research methodology developed by Larry Tabb. Since 2003, TABB Group has been
helping business leaders gain a truer understanding of financial markets issues to develop actionable roadmaps
and approaches to future growth. By accurately assessing their customer base, competition, and key market
opportunities, TABB Group works with senior industry leaders to make critical decisions about their businesses.
For more information, visit www.tabbgroup.com.

TABB Groups Equities Research Practice

TABB Groups Equities Research Practice covers market structure, trading, regulatory and technology issues
impacting global equity markets. TABB research is a critical decision-support tool that provides financial
institutions and the support ecosystem with proprietary data and analysis on trends within our community of
equity capital markets professionals. Our global clients include asset managers; hedge funds; brokers and
banks; hardware, software and services vendors; and regulators.

Author

Larry Tabb
Founder & Research Chairman
ltabb@tabbgroup.com

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission 18
US Treasury Report on the Financial System: A First Take on Its Impact on the US Equities Market October 2017

www.tabbgroup.com

New York

+ 1.646.722.7800

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission

2017 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 19