While market structure innovation may be rapid, regulatory innovation shouldn’t be, argues the Investment Industry Association of Canada (IIAC).
In his latest letter to the industry, Ian Russell, IIAC president and CEO, examines the impact of two key developments in market structure over the past few years — the rise of high-frequency trading, and the proliferation of dark pools. These innovations have helped improve market efficiency, lowering spreads and transaction costs, yet, “a trepidation and concern still hangs over investors in respect of the integrity and fairness of markets,” he notes.
Retail investors are worried that high-speed trading carried out by complex algorithms puts them at a disadvantage. And, episodes such as the near bankrupting of Knight Capital due to a huge loss caused by a software glitch, and the “flash crash” of 2010, have also been cause for concern. Dark pools on the other hand, have given rise to concerns about trading activity gravitating away from the lit market, thereby harming the price discovery process.
Given these significant worries, “It is understandable that many market participants are asking if the regulatory protections are adequate,” Russell notes. And, yet, he argues, that tighter regulation isn’t necessarily required.
In terms of high-frequency trading (HFT), Russell reports that recent discussions between high-frequency traders and stock exchange executives, reveals a general consensus that regulations and close oversight of high-frequency trading operations “will not in and of themselves guarantee that a technical problem will not arise.”
Rather, he says, the HFTs have argued that the best protection is to complement the existing regulatory framework by requiring individual HFTs to do adequate testing, and to have contingency plans in place for when systems fail.
As for dark pools, he stresses that some argue that dark pools don’t draw liquidity from traditional lit markets, and so don’t have the feared impact on the price discovery process. And, that they represent an important source of price competition to the traditional markets, which, he says, “is particularly important in the Canadian context with highly concentrated lit markets.”
Looking ahead, “innovation will be relentless and change constant”, says Russell. Yet, he cautions regulators from being as dynamic. “Regulators will need to step slowly, surely and carefully in responding to these challenges, and to rely heavily on consultation with all participants in the market to put in place the right remedies to ensure both a high standard of integrity and improved market efficiencies that will continue to benefit investors and the economy,” he concludes.