Of Frogs, Boiling Water, Market Structure and Trading
Where We are Now And Participant Inertia
Over the course of the last several years, JonesTrading has issued a number of papers covering critical issues and offering perspectives, as have numerous other market participants. What seems to be lacking is the ability to generate a conversation on anything other than on an incremental basis, rather than looking at the entire market structure. And it is this incrementalism, and the passive acceptance of it, that slowly is increasing the water temperature without reaction from market participants. The last comprehensive analysis of U.S. Markets by the SEC was the Market 2000 Report, which was shelved by the Chairman Levitt when he took office.
The sense that inertia and incrementalism are the only approaches does not necessarily have to be the case. What may be required is a systemic review of market structure itself. The Order Handling Rules and the resultant fragmentation; the facile acceptance of HFTs as "the new market makers"; the pricing models and the effects of algos and non-human intervention in trading; circuit breakers; and a host of other issues - all need examination in the context of a larger market framework.
None of the above developments are likely to go away. But they do need to interlock for the benefit of markets and investors and they do need to be integrated and examined as a whole. The idea used to be that market participants each played an essential role in efficiency. What are the roles of each of these market participants and developments and are they benefitting or hurting markets and end investors? Folks who see no need for such an examination may be concerned that their particular answer, their role in contributing to markets, may not measure up.
There was a time when any one of these events and developments articulated above would have sent reverberations through FINRA, the SEC, listing exchanges, and the market at large. And simply because conditions are new, does not mean they are in any sense normal. Unless of course boiled frog is on the menu.
Taken together, these events and developments signal a fundamental shift away from fair, liquidity and orderly markets designed for investor interest as primary. And what or who has replaced the investor as the primary interest in the marketplace? That is the question. It is almost impossible to define what participant at this point is advantaged in the current market structure, or whose interest the market is fundamentally designed to serve, despite the lip service paid to investors. They have voted with their asset allocations.
As a result of the lack of definition in roles, conditions of near savagery apply as each participant tries to eke out advantage at the margins, based on their own incremental interest. Because there is no overarching framework and consensus for participation, participants are confused.
There was a time when there was general agreement that investor protection and interest was the basis for a successful market and market structure and participants generally agreed to use that as the basis for developing competitive models. And let's not be naïve – the competitive battle was fierce and participants consistently tried with exchanges, regulators, and legislators to promote their own interests, models, and view of the world. But there was a centralized consensus, defined roles, and agreement that markets be fair, liquid, and orderly.
But somewhere along the gradual raise in the temperature, the central consensus around which all participants coalesced unraveled – and the result is that a new central consensus has not formed. As the poet Yeats reminds us:
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The best lack all conviction, while the worst
are full of passionate intensity.
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