Proposed U.S. market structure reforms would not only transform equity trading, they could also help clear the way for tokenized stock trading, says Moody’s Ratings.
Last month, the U.S. Securities and Exchange Commission (SEC) proposed a set of rule changes — including the rescission of the order protection rules, which prevent brokers from executing trades at inferior prices across trading venues — that aim to reduce the cost and complexity of the existing market structure, and to facilitate innovation.
In a new report, the rating agency said the proposed changes would have implications for both investors and various participants in the trading landscape.
“For retail investors, the key concern is the potential for weaker price protection, including a greater risk that orders are executed at less favourable prices than those available elsewhere,” the report said.
Instead of a blanket prohibition on trading through protected quotes, the reforms would shift the provision of investor protections to broker-dealers’ best-execution obligations, their oversight of execution quality and market competition between trading venues, it noted.
As for the industry, the reforms “could shift how exchanges, broker-dealers, wholesalers, electronic market makers and other trading venues currently operate, altering the existing market structure in which protected quotations and … routing practices influence order handling,” it said.
At the same time, the proposals could facilitate the adoption of trading models that operate on blockchains, which the existing market structure, and the existing rules, are not designed to accommodate, the report said.
By reducing mandatory price protections across markets, the proposals would enable “the trading of tokenized stocks through smart contracts or liquidity pools rather than through exchange-linked routing and quotation mechanisms,” the report noted.
As it stands, on-chain trading models don’t typically use the same routing and quotation frameworks as traditional equity trading venues, and don’t necessarily route orders to the venues displaying the best prices, so scrapping the order protection rule would eliminate an obstacle to on-chain trading in tokenized stocks, it suggested.
“The SEC proposal could reduce the need for tokenized trading venues to replicate the existing protected-quotation-based intermarket
model. That could make it easier for the SEC and market participants to consider a compliant framework for tokenized listed securities,
including structures that use on-chain execution,” the report said.
Ultimately, this could result in some order flow shifting away from traditional trading venues and toward on-chain trading, the report said — a development that could benefit “fintech trading platforms, digital-asset venues and liquidity providers, including algorithmic principal trading firms that participate in tokenized securities markets.”