SEC’s Market Data Infrastructure Rule Not Easily Said or Done

The market data infrastructure rule finalized by US regulators this month will bring major changes to the National Market System if it is adopted—but many of the important details of how it will work have yet to be made clear, say industry experts and observers.

The Securities and Exchange Commission (SEC) finalized amendments to Regulation National Market System (Reg NMS) that it hopes will modernize the system that currently sees the Securities Information Processors (SIPs) filter and consolidate all bid/ask quotes and trades from trading venues into one tape. There are two SIPs in the US, one for listed securities on the New York Stock Exchange (NYSE), and one for those on Nasdaq. A committee of exchanges operates each SIP. According to its final rule, the SEC feels that this system is ruled by conflicts of interest, that it no longer serves the needs of modern investors, and that more competition to the consolidated tapes is needed.

The final rule, which was proposed in February 2020, widens the definition of the “core data” that exchanges have to send to the tapes from what was essentially top-of-book data to include depth-of-book, odd-lot, and auction information. It requires the exchanges to reduce latency by sending data to the SIPs in the same ways that they send it to their proprietary feeds. And it establishes a decentralized, competitive model where, instead of two SIPs, any number of entities (called competing consolidators) could register with the SEC to consolidate and distribute core data.

Some market participants believe that the final rule is a major first step in democratizing the NMS, and have welcomed it.

“This rule is a big deal toward transparency,” says Joe Wald, managing director and co-head of electronic trading at BMO Capital Markets. “This is the first version of ‘Reg NMS 2.0,’ and with this rule, what you get is more data, more transparency for people who aren’t now going to be relegated to purchasing datafeeds directly from exchanges; they can get it from the SIP. They can get market data information around odd lots, around the depth of the book, around the close and the open, the auction process—these are all instrumental pieces of data that investors and providers of execution services need to be able to use in order to get best execution for their clients.”

Wald was co-founder and CEO of Clearpool Group, a broker-dealer that was acquired by BMO earlier this year. He has spent a lot of time over the past few years advocating for reform in the NMS, saying that high market data fees make it difficult for broker-dealers to compete.

“This is a tremendous statement of moving forward and really providing a much broader, much more democratic access to information that for a long time has been held by a small group of people who charge what they want for it,” Wald says.

Other sources, however—whether broadly supportive of the idea of competing consolidators or totally opposed to it—are more equivocal that the proposal will have the kinds of impact on the NMS that the SEC wants to see.

These sources—who have all held senior positions at exchanges and are all familiar with equities market structure and exchange data licensing and policies—say there needs to be more information from the regulators on the economic impact of the amendments on exchanges, on the governance and revenue models of the competing consolidators, and the incentives for the emergence of competing consolidators, among many other questions, says Mark Schaedel, founder of Vondelpark Capital, a fintech investment and advisory firm, and COO of Calcguard, a data management consortium for banks and asset managers.

“The SEC ruling is indeed a bold policy move, but many of the important details are still unknown,” says Schaedel, who was the former head of global market data at NYSE Euronext, and was a managing director at IHS Markit. “It would also be helpful to better understand the specific policy objectives. While it is clear that injecting competition into the tape plans is intended to address some of the governance conflicts that are often cited as inhibiting innovation, the role of the SIPs is largely operational, and the broader tape plan governance and Reg NMS rules have a much greater influence on how the tape meets investors’ needs.” 

He adds that the debates around the consolidated tapes often revolve around the costs for trading professionals, rather than investors, and that these concerns around latency are a proxy for those costs. “The SEC’s call to add depth to the tape is largely a response to it, but also a signal of their intent to introduce overdue innovation that was precluded by some of the governance-related conflicts they have alluded to in the past and begun to attempt to address with independent representation,” he adds.

Incentives for Competing Consolidators

The Commission envisages that tech companies will come forward and throw their hats in the ring to register as competing consolidators, acting as competitors to the incumbent SIPs. (This is not a new idea; it has been kicked around by the SEC since at least 2001). A source who has held various senior data-related roles at a global exchange says they agree with removing the exclusivity of the SIPs and changing the rules to further competition, though this in itself is not enough to create a competitive landscape. There has to be a commercial use-case to make it attractive for competitors and disruptors to enter the market, and this rule does not provide one, they say.

“I think the SEC would have to look at further steps around regulating the pricing of proprietary feeds, and margins, in order to close the gap between the SIPs and the proprietary data models,” the source says.

Some companies have already expressed interest in becoming competing consolidators. McKay Brothers is one, but the company has also said there wasn’t enough clarity in the proposal on whether upstart consolidators would have a level playing field to operate on, or whether exchanges would be allowed to favor one competing consolidator over another, according to the company’s comment letter.

The Miami International Securities Exchange is another that showed interest while also expressing reservations that the regulators hadn’t provided enough clarity in the infrastructure proposal. For one thing, new entrants into the market will be at a major competitive disadvantage to the incumbent exchanges if they decide to register as competing consolidators, the exchange said in its comment letter.

Governance Order

The SEC addresses some of these concerns in the finalized rule, but sources say there are too many details to work out in one document. Probably more to the point, it’s difficult to know how the competing consolidator model will work in practice when there is still another proposal that has yet to be finalized.

This additional proposal, released in January 2020, is a companion to the February infrastructure proposal, and it will restructure the voting model that decides on SIP rate sheets and revenue allocation. It orders the exchanges and Financial Industry Regulatory Authority (Finra) to rework the governance structure of the SIP committees. The Commission wants the exchanges’ plan to consolidate the two exclusive SIP plans into a single one, and reduce the voting power each exchange group has in the operating committees.

That new governance plan has not yet been finalized.

The governance model of the SIPs was established in the 1970s, when the exchanges were member-owned utilities and equities trading was concentrated. Regulators back then had no idea that in 2020, exchanges would be publicly owned, for-profit enterprises, or that their profits would increasingly come from proprietary products developed for the varied and specialized needs of a variety of players in highly fragmented markets. 

Even in 2005, when Reg NMS was promulgated and added non-exchange members to the SIP advisory committees, the SEC did not anticipate that one day the exchanges would consolidate to the point that they had an overwhelming majority vote in the operating committees. Some market participants and the SEC believe that this current paradigm represents a clear conflict of interest.

Those in favor of reforming the NMS say it is important that SIPs be forced to change their governance and boards by being forced to have representation at a board level from external market participants. It would be a catalyst for making sure that the individual business reforms and decision-making of the SIPs would follow a real-world, case-based logic, says the former exchange data exec.

But it’s still difficult to know how the decentralized system would work without knowing what this governance model would be, they say. For one, the infrastructure proposal doesn’t make it clear how revenue allocations in the SIPs will be recalibrated. Currently, the exchanges allocate SIP revenues based on an equation set by the SEC in 2007. The infrastructure proposal doesn’t address how this formula will work in the competing consolidator world. The SEC says in the finalized rule that the operating committee of the SIPs is best placed to evaluate if and how the formula should be amended.

The fine details of the finalized infrastructure proposal are probably less important than what happens to the overall governance of the SIPs, Schaedel concludes.

“It is really time to re-evaluate the role that the tape plays in today’s market structure before we can determine the appropriate role of the Sips. Doing this piecemeal will probably fall short of the potential to reinvent a tape system designed for today’s fragmented markets where investors need more liquidity insights,” he says. “By that, I mean that we should be talking about how we democratize access to data, which provides the intelligence that few firms are equipped to create for themselves and the investors themselves. This is the real challenge and the opportunity that unleashing competition to fostering innovation provides.” 

Other exchange sources agree that these rules are just the start of a process by the SEC, which no doubt intends to act further. As SEC commissioner Allison Herren Lee said while announcing the rule, “Once today’s changes are implemented, the Commission will continue to monitor the performance of competing consolidators and could determine in the future that certain minimum standards are warranted to prevent the persistence of the tiered system for market data that today’s rules are intended to address.”

An NYSE spokesperson commented, “The NYSE’s markets and data infrastructure performed exceptionally well during this year’s volatility, and we believe the SEC has hastily approved an irreversible experiment with critical systems instead of simply enhancing the consolidated tape as we recommended.”

The Equity Markets Association, a trade body whose membership comprises Intercontinental Exchange, Nasdaq and Cboe Global Markets, said in a statement that, “By hastily approving this plan without seeking industry consensus, the SEC is recklessly pursuing an agenda that will make our markets less fair at precisely the moment when they are most needed to help drive our economic recovery.” 

Nasdaq declined to comment.