Marking Your Own Homework

james-rundle-waters
How much of this is about fees and charges, and how much about genuine market structure?

The Securities Industry and Financial Markets Association (Sifma) sent a request for a review into the structure of the exchange self-regulatory model (SRO) last week, in a move that may force regulators to take an enhanced role in market oversight.

On the surface, it's hard to argue with. Exchanges have lost the member-owned, neutral utility status that they once enjoyed in the structure of the market, or at least, that's true for most of the big primary markets. Most have technology arms, most compete with participants on some level (if not directly through trading, of course), and many people I've spoken to over the years have viewed them as vendors on steroids. Market data revenue, of course, comes up in the Sifma complaint.

The regulators, too, have begun to take a more active interest in what goes on at the exchange level, particularly in the US. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have both conducted high-profile investigations of late involving bourses, and fines have been levied in response to some of them. Even on Friday, in fact, the CFTC criticized monitoring and risk management capabilities at the Chicago Mercantile Exchange group. 

Stretched Thin
If exchanges were to lose their SRO status, though, and come under direct control from the center, there are big questions over whether this would necessarily promote safety and stability in the markets. While the SEC has been upgrading its technology of late, commissioning the Midas system from Tradeworx and looking into the Consolidated Audit Trail project, the CFTC is still really struggling to get to first base, let alone cover the full circuit. It doesn't even know what to do with all of the data it's receiving from swaps reporting, and that doesn't provide a solid foundation of confidence for giving it more responsibility over vast, complex organizations like the futures and commodities exchanges.

Likewise, while there may be questions of conflicts of interest stemming from some areas of exchange operations, and there have been consistent and well-documented criticisms of exchange policies from market participants, this does seem a little pedantic in its approach. Exchanges are SROs, yes, but there are elements of central regulation already. Most have to submit their rule changes to the relevant regulator before they're passed, and any regulator can fine and punish errant institutions.

Perfect Worlds
Sifma is right, to an extent. In a perfect world, exchanges would be overseen by central regulators, and in the modern climate it does make sense for that to occur, at least while they're operating as commercial enterprises. However, there has to be an element of practicality to this, and a trade body suggesting that regulators spreading themselves even further over a market while already operating under constrained conditions does not a convincing argument make.

If exchanges were to lose their SRO status, though, and come under direct control from the center, there are big questions over whether this would necessarily promote safety and stability in the markets.

Rather, to restore confidence and bolster it, what is needed is reform at the exchange level. Rather than placing the marketplaces under the aegis of a regulator unable to oversee them, instead we should be looking at why the SRO status is unsuitable, and instituting changes at the entity itself to adjust that.  

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