WASHINGTON, April 5 (Reuters) - A proposal by U.S. securities regulators to require exchanges to improve protection against technology glitches and natural disasters is too narrow and should include more market players, a top New York Stock Exchange official said Friday.
The plan, released by the U.S. Securities and Exchange Commission last month, calls for exchanges, clearing agencies and certain larger trading venues like “dark pools” to test their systems and alert regulators about market disruptions.
Dark pools are venues that allow investors to trade stock without tipping their hand to the broader marketplace.
But the proposal does not cover “internalizer” broker-dealers that execute trades internally and compete with exchanges directly for volume. As of February, broker-dealer internalization made up 19.8 percent of trading volume in exchange-listed stocks, according to the TABB Group.
“I think any major market participant should be covered. It doesn’t really matter what form they take,” said NYSE Euronext’s Chief Operating Office Larry Leibowitz in an interview with Reuters on the sidelines of the Society of American Business Editors and Writers conference in Washington.
“If they go down, it has an impact on the market.”
The SEC’s proposed rule formalizes a set of voluntary and outdated standards known as “automation review policies” that were initially developed as a response to the market crash of 1987.
Those guidelines primarily targeted exchanges and clearing agencies. But market competition has increased greatly since then, especially with the rise of internalization and dark pools.
The SEC has long contemplated formalizing the guidance into rules that could be enforced if violated.
But the SEC finally put the rulemaking on a fast track last August, after brokerage Knight Capital nearly went bust due to a software glitch that led to $440 million in losses.
Initially, SEC staff had said the new rules would not just be applied to exchanges, but also to other venues that compete with exchanges for trading volume, such as broker-dealers who can also experience problems that could send markets into a tailspin.
When the rule was unveiled last month, the SEC only expanded it to cover some of the higher volume-generating “alternative trading systems,” most of which operate as dark pools.
The agency left open the possibility of imposing some requirements on brokerages, but said any changes would be tackled in a different rulemaking.
Leibowitz said he recognized that not all of the standards proposed in the rule should be the same for brokerages as for exchanges.
But he said it would not make sense to pile on requirements for exchanges without addressing other significant market players.
Doing so, he said, could impose undue and disproportionate costs on exchanges, and added that the SEC needed to do a strong economic analysis before adopting a final regulation.
Problems with the quality of its economic analysis have gotten the SEC in trouble in the past, with industry groups like the U.S. Chamber of Commerce legally challenging SEC rules on those grounds and winning.
“If all we do is add to the burden of exchanges without looking at the rest of the market, then all we have done is further tilt the balance against exchanges,” Leibowitz said.
He also did not think smaller dark pool venues or other smaller venues generally should be excluded from the rule.
“It’s not clear to me there should be a de minimis exception,” he said. “If you’re a participant in the market, then why should your barrier to entry be lower than someone who is bigger?” (Reporting by Sarah N. Lynch; Editing by Bernadette Baum)