For some years, there has been a raging debate over the health of the equity capital markets – how to address market volatility, complexity, conflicts of interest, the rise of high-frequency trading, and more. For the most part though, these discussions take place outside corporate boardrooms and without the participation of corporate issuers.
To illustrate, in the dozens of conferences, roundtables, and hearings on market structure I’ve attended over the years, as a regulator and in the private sector, I can’t remember a single time when a corporate treasurer or chief financial officer has been represented or the agenda has focused on the interests of corporate issuers. That makes no sense, and it needs to change.
Why? Because corporate issuers have as big a stake as any constituency in the health of our trading markets. Because they rely on the markets to raise capital cheaply and efficiently. And because to protect their stake they need to know that the markets work well for their employees who hold stock and also for people who invest in their stock, not just the people who make money by trading it.
One of the most important conditions of a healthy market is the ability of exchanges to play an effective role in building a bridge between corporate issuers and investors. For that reason, exchanges are supposed to look out for the public interest, not just their own. Unfortunately, today, the reality falls far short of that ideal. Consider the following points:
- Exchanges today are heavily invested in the business of selling technology and preferred access to traders who profit from speed advantages when trading with “natural investors,” the asset managers, pension funds, and individual and other investors who supply long-term capital to companies. There is no question that efficient markets need the active participation of trading firms, but the interests of exchanges are far too heavily weighted in favor of speed-based trading strategies that account for a major share of their volume.
- Exchanges spend a huge amount of effort designing specialized order types and price incentives that attract high-speed traders. Under some pricing schemes, high-speed traders are paying exchanges to post bids or offers in order to benefit from trading with “uninformed order flow”, in industry parlance. Other times, exchanges are paying high-speed traders to “provide liquidity”, which can be fleeting at the first sign of distress, a time when a real liquidity provider is most needed.
- Exchanges also generate over $600 million in annual revenues from listing and other fees from corporate issuers, which is a reliable profit source even in an era when shares can trade on dozens of venues and the value of listing on one of the two major listing markets has fallen substantially.
- Finally, some exchanges claim to curb excessive volatility but end up causing it! On August 24th, we witnessed the chaos that can ensue when exchange procedures designed for a different era lead to wild gyrations in prices at the opening of trading.
At IEX, as we prepare to launch the Investors Exchange, we have been thinking a lot about what it should mean to be an exchange and the responsibilities that entails. When we look at the state of today’s market, we do not see exchanges fulfilling this role effectively. We firmly believe that IEX can be an agent of change by offering the choice of a new exchange that is fairer, simpler, and more transparent. There are many specific ways in which our exchange is designed to do so but all of them stem from the conviction that exchanges exist, above all, to serve investors and the companies that rely on them to grow.
John Ramsay is Chief Market Policy Officer for the IEX Group (email@example.com) He was previously Head of Trading and Markets at the Securities Exchange Commission.•