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A Level Playing Field for Surveillance

View from John Zecca, Head of U.S. Market Regulation at NASDAQ OMX on subjecting all trading venues to the same rigorous transparency and market surveillance standards.

Over the last decade, a significant amount of equity trading volume has migrated to broker-dealer operated alternative trading systems (ATSs). These exchange-like OTC trading platforms, including dark pools, have different levels of transparency and are only accessible to their participants.

To ensure overall market integrity, it is critical to subject all trading venues, including regulated exchanges and dark pools, to the same rigorous transparency and market surveillance standards. 

The U.S. market is among the most fragmented in the world, and is setting an example for other markets that are opening their doors to competition. 

Dark pools in the U.S. report their transactions through one of several Trade Reporting Facilities (TRFs). While dark pools do not have a traditional order book per se, they do provide certain data to an audit trail called the Order Audit Trail System (OATS) that is available to the Financial Industry Regulatory Authority (FINRA). FINRA aggregates data from exchanges and dark pools and integrates it into its surveillance patterns. However, because ATSs are not obligated to provide FINRA with full information on their order book activity, FINRA does not receive as much data from dark pools and other ATSs as it gets from exchanges.  As a result, there are opportunities to enhance FINRA’s surveillance of these market centers.      

There are also differences in operational transparency between dark pools and exchanges. Exchanges must file their operating rules with the SEC, but dark pools only have to provide a description of their order handling process, their customer base and their subscriber requirements.  While exchange rules are publicly available and subject to notice and public comment, dark pools submit this more limited information confidentially to the SEC.

FINRA is reviewing how to better identify dark pool trading data and whether users are provided with adequate descriptions of how dark pools work. Participants’ activities are also monitored for misconduct. For example, regulators are reviewing whether trading in one venue is used to impact activity at another.  These are important steps to ensure market integrity.

While we are making great strides in consolidating the information needed to conduct cross-market surveillance and to level the playing field for all venues, we are not there yet. Some outstanding issues will be addressed by new regulations and processes such as the Consolidated Audit Trail (CAT) and the recently adopted Market Access Rule. If approved, the SEC’s proposed Regulation System Compliance and Integrity (SCI) will replace voluntary compliance with enforceable rules on development, testing, monitoring and reporting of critical trading and systems technology issues.   It is important that Reg SCI rules extend to all trading venues.  

Most regulators agree that the quality of surveillance cannot vary by venue. Transparency and complete information aggregated across markets is the best remedy to protect investors.


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