Report of the
Advisory Committee on Market Information: A Blueprint for Responsible
Change
February 4, 2002
Background
A
"request for ruling" on market data fees by Charles Schwab & Co. to the SEC
started a process of inquiry on the issues relating to the public availability
of market data. The request for ruling grew out of the rise of Internet trading
and focused on the issues related to data usage, redistribution and payment
policies. The request for ruling resulted in a
concept release by
SEC staff (FISD
summary of concept release). Over 40 organizations provided comment letters
to the concept release. After evaluating the comment letters, the SEC created a
federal advisory committee
to address a broad range of issues on the concept of the national market system
and the definition of transparency.
The
Advisory Committee consisted of 25 members (including exchanges, vendors,
brokerage firms, investment managers, academia and FISD) plus staff from the SEC
Division of Market Regulation. The Committee addressed a whole range of
fundamental and practical issues including the definition and benefits of price
transparency, the role of exchanges in information competition, the
consolidation of market information and commercial/governance issues related to
fees and plan administration. The
final report from the Advisory Committee was delivered to the SEC on
September 14, 2001.
US Market Structure
The
U.S. central market system was created when Congress enacted the Securities Act
Amendments of 1975. That Act directed the Securities & Exchange Commission to
create a national market system to maintain stable and orderly markets and to
centralize buying and selling interests for best execution. Section 11A of that
Act outlined three rules that are critical to the regulatory subjects under
debate among Advisory Committee members.
-
Transactions Reporting Rule (11Aa3-1) requires exchanges to file a
transactions reporting plan for securities traded on its market. This rule
requires the consolidation of feeds and established SIAC and UTP as securities
information processors. It also set up the requirement for best execution to
ensure that retail investors received the same price as institutional
investors.
- The
Quote Rule (11Ac1-1) requires exchanges to make bids, offers and quote sizes
available to vendors. Before 1975, exchanges determined who could or could not
get access to market data.
- The
Display Rule (11Ac1-2) requires vendors and broker/dealers to provide a
consolidated display of information in the form of either a National Best Bid
and Offer/NBBO or a quote montage. Prior to 1975, vendors decided which
information to include in their displays.
Issues Being Addressed
The
Advisory Committee met six times (plus two subcommittee meetings) over 10 months
and received numerous comment letters and concept proposals from the financial
industry. Lots of issues were discussed. Most are well documented in the meeting
minutes, final report and comment letters. Here is my assessment of the
essential issues under debate:
Definition of Transparency. What is a transparent market? How is
transparency achieved in our market system? Is the current level of
transparency sufficient? What is required to ensure transparency?
Consolidated Data Feed. The concept of a consolidated data feed was
created in a technological environment that is quite different from the one
that currently exists. Is it still necessary? If so, is the current structure
of a single consolidator still valid or should the Commission open the means
of consolidation up to competition?
Access to Data. The issue of access is really about two things –
what data is made available and the business models governing data usage. In
terms of what data – is the NBBO alone sufficient or is more enhanced data
required? Do the exchanges have the right to make money on “non-core” data? If
so, what is the definition of “non-core?” In terms of business models – are
they fair? And should the exchanges or the Commission set the business
policies governing market data?
Cost of Market Data. Is the current fee setting structure
appropriate? Are the current fee levels discriminatory? Is the revenue sharing
structure of the plans appropriate? Will for-profit exchanges put the needs to
their shareholders above the needs of the investing public?
Capacity Issues. Has decimalization and growing quote traffic
reduced the value of the NBBO? Can anything be done to mitigate quote traffic
in the options industry?
Data Ownership. The concepts of market data ownership were not
discussed to a significant degree by the Advisory Committee – but are an
underlying factor in evaluating the final report. Who owns the data – the
brokers who generate orders? The public? In essence, are the exchanges the
creator or just the collector of market data (i.e. does the findings in the
Feist case apply to market data)?
Transparency and the Display Rule
Price
transparency is a cornerstone of the U.S. National Market System. It facilitates
best execution of orders, promotes investor protection and mitigates
fragmentation of buying and selling interests among different market centers.
The NBBO (best quotation and last sale with volume and market identification) is
the most basic form of a fully transparent market and fundamental for the U.S.
system.
But
does the existing system achieve the appropriate levels of transparency? This
question is particularly important because decimalization that has increased the
number of price increments and reduced the depth of trading at each price level.
Because of that, most members of the Advisory Committee believe the NBBO is less
meaningful. They wanted the SEC to promote exposure to the full depth of book.
They also wanted to see quote competition as an incentive for the exchanges to
produce “useful” data.
[NOTE:
NYSE OpenBook and Nasdaq
SuperMontage – offered as enhanced commercial data products from the
exchanges - provide exposure to the depth of market.]
Display Rule
In many
ways, the discussion about market transparency is a discussion about the display
rule – because remember, before the display rule some vendors only provided
trade and quote information from the primary market. There was much passionate
debate about the display rule in the deliberations.
Those
who favor its retention argue that it is essential to ensure that the
information provided contains the best quotes/trades from all markets. Without
the display rule, investors would not know what data was excluded or when a
better price was available on another market. They also maintain that without
the display rule, it would be difficult for investors to monitor the execution
of orders. The Commission also argued that eliminating the display rule could
mean less inter-market competition in that vendors would no longer be required
to distribute information from a new market. The unfortunate result would be
that new markets could have difficulty attracting limit orders if information
from that market was not widely distributed.
Those
who were against its retention argued that market forces and best execution
obligations would result in higher quality, affordable information. The essence
of their case was that market forces, rather than regulation, should determine
the nature of the market data provided. They also maintained that the ability to
choose the level of data to be received could result in a lower overall cost for
market data users and permit them to better evaluate the cost-to-value ratio of
the data. In essence, if there were no requirement to include all data in the
display, non-primary markets would have to price their information based on
value. In order to get market data revenues, markets would have to compete on
price/quality of data.
Advisory Committee Report Recommendation
The
final report reinforces the concept of market transparency as a fundamental
component of the National Market System. It also maintains that consolidated
information is an important component of market transparency and will continue
to be important as volume increases.
- The
final report recommends that the display rule – mandating that all data from
all markets -- be retained.
- The
final report recommends that market centers be allowed to sell their data
independently – as long as they are providing that data (at the same time) to
the consolidators.
- The
final report recommends that market centers should have the flexibility to
distribute additional market data beyond the mandated core (and outside of the
consolidated stream mandated by the display rule).
- The
final report also suggests that non-SROs should be allowed to offer their core
data independently as long as they are providing that data to the appropriate
SRO at the same time. This recommendation requires amendment of the
Transactions Reporting Rule.
Consolidated Data Stream
The
concept of a central processor was developed in the 1970’s as the most practical
and reliable way (at the time) to generate a consolidated stream of data. The
question before the Advisory Committee was not whether we should have a
consolidated quote (the Committee believes we should) but whether the existing
single consolidator model continues to make sense.
The
Advisory Committee spent a lot of time discussing this issue. The discussion was
complex and quite contentious – in that it is hard to debate the concept of
competing consolidators without including discussions related to the display
rule and information competition. This discussion was more often than not about
the issues of information competition rather than the issues related to the
means of consolidation.
Means of Consolidation
If
we’re just talking about the means of consolidation – most members of the
Advisory Committee intuitively favor a model that allows individual markets to
sell their data to a number of competing consolidators. Most agree that
technology has evolved and there is little justification for requiring markets
to act jointly to produce a consolidated market stream. That being said, it’s
important to recognize that the current securities information processors (SIPs)
do a very competent and cost-effective job of data consolidation. In addition,
there are quite a few systemic risks --- related to sequencing of information,
validation tolerances, capacity and data formats -- associated with the
competing consolidator model. In essence, if the Commission retains the display
rule, there is little benefit – other than the belief that the free market will
be more innovative – and some (potentially significant) economic and
technological risks to the multiple consolidator model.
Information Competition
Underlying the discussion about data stream consolidation were the questions
associated with how to foster competition in the dissemination of market data.
Some maintain that the recommendations in the final report only focus on one
segment of the information chain. They maintain that the competing consolidator
recommendation will produce little because exchanges still have the sole right
to sell market data to vendors – and vendors and broker-dealers will still be
compelled to buy it from them.
They
argue that exchange would retain exclusive control over access to (and fees for)
market data and will face no competitive pressure to provide data on a more
efficient, economic and useful basis. They argue that the crux of the issue is
that SEC rules require market participants to give market data to the market
centers (Quote Rule) and then requires them to buy that information back in a
consolidated form (Display Rule). They believe this regulatory structure offers
little competitive incentive for exchanges to price efficiently. They also
maintain that the regulatory structure prevents firms and vendors from offering
competing products -- such as depth of quote – because the rules prohibit
vendors from distributing their own data products unless they also purchase and
distribute the data from the market centers.
[Note:
One of the primary objectives was to explore ways to increase the amount of data
available to investors. Since the release of the Advisory Committee
recommendations, both NYSE and Nasdaq have offered depth of book products – with
other new data products on the horizon.]
Advisory Committee Report Recommendations
- The
report presents both majority (permit individual markets to sell their data to
competing consolidators) and minority (retain the current model with
improvements) views.
- The
report concludes that the competing consolidator model is technologically
feasible and that the risks are manageable. It also suggests that the economic
benefits of competition and innovation outweigh the costs and risks of
“monopoly pricing” and reduced efficiency.
Market Data Administration
The
subject of market data business policy and administration was the subject of a
lot of passionate debate. On request by the SEC, FISD prepared and submitted a
paper to the Advisory Committee on market data business issues. The objective of
the paper was to outline the current issues and identify some of the
complexities associated with market data management. There was also a
significant amount of discussion on plan governance and voting procedures. Much
of the discussion about both plan governance and administration stemmed from a
lack of understanding on the part of the Advisory Committee members about these
topics.
Advisory Committee Report Recommendations
- The
report recognizes the complexity of these issues and encourages the industry
to work cooperatively (and with FISD) to:
-
Promote full transparency of fees, contractual terms, business requirements
and administrative procedures
-
Develop clear and consistent interpretations of market data policies and
contractual requirements
-
Simplify and rationalize market data business practices particularly related
to prior-approval, user classification, unit of count, subscriber
agreements, billing and reporting and data usage
-
Use technology to automate all areas of market data administration
- The
report suggests the potential of creating a non-voting advisory committee on
plan governance.
[Note:
Prior to the SEC Advisory Committee, the NYSE was in the process of launching a
new infrastructure for market data administration. The goal of the NYSE is to
promote customer, inventory and reporting transparency. NYSE is continuing to
invest a significant amount of money in this new infrastructure and has unveiled
a number of initiatives designed to streamline administration.]
Fees
and Revenues
One of
the initial mandates from the SEC was for the Advisory Committee to examine how
market data fees should be determined and how the fairness and reasonableness of
fees should be determined. It was no surprise that the Advisory Committee spent
a lot of time discussing how fees are set and the role of the SEC in fee review.
As part
of the concept release, the Commission outlined an approach to setting a
cost-based limit on the total market data revenues of the exchanges. After
widespread discussion, the conclusion was that a cost-based approach to market
data was both unnecessary and impractical.
There
was also some discussion about the potential of establishing a “most favored
nation” pricing structure that would require all purchasers of data be charged
no more than the lowest fee charged to any market data recipient. The net result
would be to eliminate volume discounts – and the concept did not receive much
support among the members of the Advisory Committee.
One of
the bigger debates was on the question of revenue sharing among the exchanges.
Prior to the initial meeting of the Advisory Committee, the Board of the NYSE
authorized the exchange to withdraw (pending SEC approval) from the Consolidated
Tape Association. One of the key reasons behind this action was that the NYSE
did not want to share market data revenues with other exchanges that didn’t “add
value to price transparency.”
It’s
still unclear whether the SEC will allow the NYSE to withdraw. There are two
likely impacts if they do. First, all exchanges operating within CTA would be
able to set their own fees and manage their own contractual and administrative
processes. The implications could be to both increase the administrative
requirements on re-distributors and enable market forces to work by rewarding
more efficient markets. Second, it would put pressure on the regional exchanges,
who generate a significant number of auto-quotes (to gain market data revenue),
to add more value to the price discovery process.
Advisory Committee Report Recommendations
- The
final report recommends no change to the statutory standard – of fair
reasonable and not unreasonably discriminatory – under which the Commission
reviews market data fees and revenues or to the manner in which the SEC
conducts this review.
Capacity and Quote Mitigation
The Advisory Committee spent one meeting talking about the structural and
regulatory differences between the equity and options markets. On request by the
Commission, FISD made inquiries and submitted a
report on the impact
of options data on market data vendors and user firms.
The
objective of the inquiry was to:
-
Identify the issues associated with options capacity as it applies to
distribution bandwidth and processing capabilities.
-
Collect opinions on the value of an official NBBO for options or other data
elements required for transparency in the options market.
-
Identify issues associated with the methods and approach to consolidation of
data.
-
Collect opinions on alternatives for consideration.
Advisory Committee Report Recommendations
- In
light of capacity concerns facing the options markets, the Advisory Committee
recommends that options markets do not move to penny increments.
- The
final report recommends that an NBBO should be calculated for options at the
consolidator level.
- The
report states that size of trading interest at the NBBO is critical to
understanding market conditions and the information should be disseminated
with the NBBO.
- The
report recommends the dissemination of a market identifier with the NBBO.
- The
report suggests that the options exchanges should aggressively pursue quote
mitigation strategies including the potential of a request for quote system
for less actively traded securities; more stringent listing standards and more
aggressive delisting policies; desensitization of auto-quote systems; and
modification of the firm quote rule to reduce the need to auto-quote “out of
the money” and away from the market quotes.
Data Ownership Issues
The
issues of data ownership were specifically excluded from the Advisory Committee
discussions – but are worth mentioning in light of the inquiries by the U.S.
Congress on database protection.
The
debate on database protection grew as a result of a Supreme Court decision where
Feist Publishing copied a phone company white page directory and was sued by the
phone company for copyright violation. The Court ruled that the White pages were
simply a collection of facts – and even if difficult to collect – not subject to
copyright protection.
This
ruling has created a stir among information companies in that many databases are
compilations of facts. They are petitioning the Congress for database protection
legislation to give them some additional degrees of protection for their
intellectual property. From a market data perspective, the relevant question is
whether market data prices are “facts” and whether the exchanges are the creator
or just the collector of market data. In essence, does Feist apply to market
data.
Some
organizations are trying to make the case that it would be a mistake to grant
exclusive proprietary ownership rights to the exchanges before reviewing the SEC
policies that create regulatory “monopolies” for the producers of market data.
They maintain that -- by regulation -- broker-dealers are required to be members
of the SRO, required to report transactions, required to display consolidated
information and required to include data from every market center in the
consolidated quote. They maintain that there are no competitive forces at work
and that the ownership of data is solely due to the regulatory structure. The
discussion within the Advisory Committee reaffirmed the right of exchanges to
charge for market data. It’s quite possible that the issue of data ownership in
the financial industry will re-emerge on the agenda of the U.S. Congress.
