A DIFFERENT TAKE. 

It is hard to keep up with the regulatory and market changes in the US but Rosenblatt Securities gives clients the tools they need to stay top of their game. President and COO Joe Gawronski explains.

A. The US has seen a perfect storm of significant market structure transformation, post-crisis political and systemic risk concerns, and, more recently, the May 6th flash crash. These events have put a lot of pressure on regulators to act, but in some instances their desire to act is simply not there and regardless it will take time to agree upon the rules deemed necessary. As a result, our view is that regulatory action will be much slower and less dramatic than people expect. The SEC alone has 90+ rules to write for Dodd Frank implementation. The regulators rightly are dealing with complex issues with care, and in general I do not think they will want to radically upset the fabric of the market structure that they created.

In terms of the changes, I think there will basically be a few tweaks around the edges of the market structure. I don’t think all of a sudden the regulators are going to stand up, do a 180 and take a mea culpa saying, ‘The past 15 years of rulemaking has been a mistake. Let’s go back to a manual market.’ I do not expect them to outlaw substantial things like co-location or impose minimum time-in-force quoting obligations that would destroy high frequency trading. Instead, the changes will continue to focus on areas relating to systemic risk such as sponsored access rules, further changes to the operation of the circuit breakers, and de minimis market maker obligations, as well as broker/exchange routing transparency, including around dark pools and flash orders.

Q. How do you think high frequency traders will be addressed?

A. There is nothing new about high frequency trading. In fact, if you look at the SEC’s history, it has been a champion of automated trading, partly because of the surveillance capability that automation provides. The SEC adopted Reg ATS and all the order handling rules back in the late ‘90s, which created the fragmentation that exists today. Then they brought changed the minimum increment to16ths and ultimately decimals, which further decimated the traditional market makers and fostered HFT. In 2006 the SEC adopted Reg NMS, which endorsed the high frequency trading that already dominated Nasdaq trading and forced change on the NYSE market structure. In fact, high frequency trading did not become an issue until 2009 after the financial crisis and politicians were looking for a culprit.  And while some may complain about how these traders are distorting the market, statistics on spreads, volatility and overall transactions costs show that the market quality has actually improved during their ascendance.

Q. What do you think will happen with dark pools?

A. Although the focus is on the US and Europe, there are some interesting things going on in Canada. The regulator has just come out with a position paper that suggests that internalization can only be justified if minimum order sizes are met or meaningful price improvement is delivered. While the SEC is certainly considering similar solutions (the “trade at” rule in US parlance), I think there are much better odds that the Canadians or Europeans end up with such restrictions than the US.  [Interestingly, Canadian regulators have also proposed that regulatory costs be allocated to exchanges and brokers based on message traffic, which addresses something about the current cancellation heavy HFT-dominated market structure Europeans, Americans and Canadians alike have pointed out as inequitable.]

Q. How do you see the broker role changing?

A. It is a definitely a more complicated world today. We used to have two distinct market structures – the NYSE floor for trading NYSE-listed stocks and market makers for Nasdaq. The NYSE market structure for example was very simple and oddly transparent. To get good execution you had to go down to the floor. You could use DOT, an automated delivery mechanism, but even with that, there was a manual process requiring specialist interaction. So when you sent your order to the NYSE, you knew what happened and if you ever visited the floor you knew exactly how it worked. Today, the rise of competing venues has brought choice and lowered explicit transaction fees as the monopoly has gone away, and the buyside is more empowered than they ever have been. They push the button to send the orders and have all the tools on their desk that the sellside has. However, at the end of the day, they have a lot less understanding and transparency as to where that order is going in this complex market structure.

As a result, there is a greater need for a broker to help the buyside navigate the market and to make sure that its own trading desk can navigate the market effectively. This means brokers have to be true execution consultants, a term that is often used but seldom really practiced. The market structure work we started doing eight years ago has allowed us to demonstrate that execution has not been as commoditised as some might think. The fact that we’re independent and not hawking any proprietary venues or tools gives us a more credible perspective about what is happening in the dark pools, how the algos can best meet the needs of our clients, how to measure transaction costs and toxicity of venues, and so on.

Q. Do you think best execution has become easier in the wake of the regulation?

A. I think the idea of achieving best execution is almost a joke today, although striving for best execution is something we and a few other brokers still take very seriously. It is very difficult, even with all the transaction cost analysis tools on the market, to measure best execution because of the degree of fragmentation that exists. You can try your hardest to achieve it and I think we come as close as anyone does but you can never say on any given trade with certainty that you achieved best execution because you don’t know where all the hidden orders are. It’s impossible to even be connected to every venue out there, because you can only have one or two order management and execution management systems and none of them connect to everyone. And sadly most brokers today make their routing decisions based upon how expensive one venue is relative to another. Only a few make their decisions based upon best execution and liquidity.

Q. Tell me a bit of the history of Rosenblatt and the market structure group that you run?

A. Dick Rosenblatt started the firm in 1979 as an agency only broker on the floor of the New York Stock Exchange. He was one of the first to move upstairs in the 1980s to offer trading in Nasdaq stocks as an agent as well as programme trading.  [We also were early to embrace technology and were in fact the very first firm to introduce automated trading in the form of DOT access to the buy-side.]  Today, I think one of our main differentiators is our market structure research. It makes our own trading desk better and not only provides in-depth research on market structure to buyside traders, but also granular analysis on the exchange space to analysts and portfolio managers, though we eschew traditional Wall Street buyside ratings, earnings estimates and price targets. Three years ago we hired Justin Schack (former assistant managing editor at Institutional Investor) to the newly created position of vice President, Market Structure Analysis to help develop the product.  He has since been made a director.

The group publishes a monthly news digest which offers our take on important market structure and regulatory happenings, as well as our Trading Talk reports that provide more in-depth looks at important developments, such as the rise of high frequency trading, evolution of US option markets, European fragmentation and the like. For instance, ETFs are a topic we are doing a lot of work on now since they have become a much bigger part of the market and we have found we can add a lot of value in trading them on the desk, but there are things we have learned that we want to share with our clients. We also have Let There be Light reports which are considered to be the industry’s premier source of information about non-displayed liquidity in the US and Europe since their launch in early 2008.