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Gallagher Calls for Holistic Review of Markets, Warns of Fixed Income Risks

SEC Commissioner Dan Gallagher called for a holistic review of equity market structure in a speech earlier this week. Gallagher suggested a de novo review for certain regulations, including Reg NMS, a regulation promulgated by the SEC in 2005 in order strengthen and modernize equity markets. He took specific aim at the trade-through rule, which according to Gallagher distorts market competition by preventing exchanges from truly competing for order flow.  As an alternative, he suggested clarifying the best execution obligation of brokers, adding factors in addition to price in a way that mirrors FINRA’s version of the rule.

Gallagher also questioned the status of exchanges as self-regulatory organizations, noting that most exchanges have outsourced surveillance and regulatory obligations to FINRA.  In addition, he discussed the increased use of alternative trading systems which are “nimbler and better equipped to make quick adjustments to their operations” because they are not subject to the same regulations as SRO exchanges. Gallagher suggested that the market structure review should include a consideration of whether exchanges and alternative trading systems should continue to be subject to different regulations in order to level the playing field.  

Lastly, Gallagher took issue with securities information processors (SIPs) in their current format as a “public utilities.” He decried that the lack of competition in providing consolidated data thus creating a single point of failure as demonstrated by the August 2013 suspension of trading on NASDAQ , and the potential conflict of interest in that the two current SIPs are owned by exchange affiliates.  Gallagher highlighted the prominence of exchange-provided direct data feeds as a market-based solution, and suggested that the SEC could strengthen this approach by mandating that exchanges provide third-party aggregators fee-based access to the direct feeds.

Turning to fixed income markets, Gallagher argued that the FSOC is “oblivious to an actual systemic risk percolating right under their noses.” The opacity of the markets combined with high retail participation and impending interest rate hikes amounts to the possibility of a free fall in prices, according to Gallagher. To resolve these issues, he argued that the Commission should require greater price transparency and facilitate on-exchange transactions by adding incentives for issuers to standardize offerings.  Gallagher also suggested that issuers should adopt ISDA-like contracts for offerings, which would standardize terms in debt offerings much like the ISDA contracts have for swaps.