The Beginning of a New Era for the SEC?

SEC Chair Gary Gensler detailed an agenda that is likely to chart in part the direction of the agency over at least the next several months in his testimony last week before the House Committee on Financial Services (here). The agenda includes the following: 1) Gamification and Unser Experience; 2) Payment for Order Flow; 3) Equity Market Structure; 4) Short Selling and Market Transparency; 5) Social Media; 6) Market Plumbing: Clearance and Settlement; and 7) System Wide Risk.” These issues which will be discussed in a report to be issued later this summer.

The six issues listed reflect the rapidly changing market environment created by evolving technology as well as the events in the markets earlier this year. The critical question presented by this evolution is, according to Mr. Gensler: “When new technologies come along and change the face of finance, how do we continue to achieve our core public policy goals and ensure that markets work for everyday investors?” The answer to this question is not simple as illustrated by a brief look at each question:

1) Gamification is a term that encompasses an expansive range of ideas. It begins with the game-like features used with online devices, builds on tech that includes behavioral prompts designed to encourage users to engage with an app and links to features that employ predictive data analytics. While the prompts can be useful and enhance user experience, “following the wrong prompt on a treading app . . . could have substantial effect on a saver’s financial position,” the Chair noted. To evaluate this question the Commission plans to seek public input.

2) Payment for Order Flow, which is prohibited in some countries, comes in two forms: Payments from wholesalers and those from exchanges to market makers and brokers. Mr. Gensler is focused on those from wholesalers to brokers since they transmit information to the purchasers who are not obligated to offer fair access to it – the wholesalers can use it as they determine. This creates a competitive edge. It also presents questions that include potential conflicts of interest and best execution. These are questions that must be evaluated by the staff.

3) Equity Market Structure today presents issues regarding concentration. Currently about 53% of the orders are executed by the large public markets; 47% are executed by either off-exchange wholesalers (38%) or alternative trading systems (9%). Since concentration can result in a competitive edge the agency is going to examine the question in view of its rule making authority.

4) Short Selling was one of the key issues in the market events earlier this year. While there are reports available on the question that afford transparency into the practice, the Commission is going to examine this issue.

5) Social Media is having an impact on the markets as reflected in the events that took place earlier this year. One point to consider, Mr. Gensler notes, involves “sentiment analysis” which is being used by some sophisticated investors. It involves following public communications to assess relationships between words and prices. Since it can be used for nefarious practices such as to manipulate a market, the agency will study the process.

6) Market Plumbing is a question that focuses in part on settlement time, currently T+ 2, the gap between the order and the transfer of the cash and securities. While the time has varied over the years – in the 1920s a one day cycle was used – Mr. Gensler believes that “the standard settlement cycle could reduce costs in our markets” if shortened.

7) System-wide Risks includes there key points: a) the impact of broker liquidity when large sums of capital need to be raised quickly as occurred earlier this year; b) the potential impact of losses suffered by certain hedge funds this year; and c) the concentration among market makers or brokers at clearing houses which can also have market impact. Each of these points will be evaluated by the staff.

Evaluation of these difficult and complex issues will chart much of the Commission’s path for at least the next several months. As the assessment evolves at least one report will be issued to update Congress and the markets. In addition, there will be opportunities for the public to give input to the agency and possibly enforcement actions. By the time those occur they may well represent not the end of these projects but the beginning of assessing the ever evolving impact of tech on markets that originated decades ago – a new era for the SEC.

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