United States: SEC Chairman Asks Staff To Consider New Rules To Manage Risks Highlighted By Game-Type Trading Applications
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SEC Chairman Gary Gensler testified yesterday before the House of Financial Services Committee on the SEC’s efforts to assess and address the market volatility that has occurred in GameStop and other “meme stocks” resulting in significant price volatility and spikes in trading volume earlier this year.
Gensler said the SEC is working to determine, in the face of technological and financial changes, how to continue to meet key public policy goals while making sure markets work for everyday investors. Gensler cited seven factors that were at play during volatile trading times:
- Gamification and user experience: Mobile apps have expanded access to financial markets, allowing investors to register, start trading, get wealth management advice and learn more about investing. The apps use a host of familiar online features, such as gamification (points, rewards, rankings, bonuses, and contests), behavioral prompts, and differential marketing, to increase customer engagement.
- Gensler said staff are preparing a request for public input to examine these issues and determine how to ensure investors using apps with these types of features are properly protected and how the SEC rules, including Best Interest regulation, apply in these situations. Gensler noted that many SEC regulations were written long before today’s communications technologies and practices existed and that they must be reassessed to protect the future, retirements and education of the investing public.
- Order Flow Payment: Gensler noted that in recent years, most retail brokers have stopped charging fees for transactions and are now earning income through other streams, including a process called payment for order flow. The two main types of payment for order flow are (i) payments from wholesalers to brokers, and (ii) payments from exchanges to market makers and brokers.
- Gensler explained that in the first scenario, retail brokers make deals with wholesalers, who buy their order flow. Unlike public exchanges which must offer fair access to their publicly displayed quotes, these wholesalers can decide to execute these orders directly or transmit them for execution by exchanges or other trading venues, allowing wholesalers to obtain valuable information of this order. flows that other market participants are getting late, if at all. Gensler noted that neither the UK nor Canada allowed brokers to route retail orders to over-the-counter market makers in exchange for payments.
- Structure of the stock market: The US stock markets essentially have three different segments:
- Public exchanges like the Nasdaq and the New York Stock Exchange, which accounted for around 53% of market volume in January
- Alternative trading systems (such as dark pools), which accounted for around 9% of trading volume in January
- Over-the-counter wholesalers, who made up the majority of the remaining 38%, with just seven wholesalers performing the vast majority of transactions, which Gensler said raised concerns about whether the market structure of fair, orderly and efficient markets
- Short selling and market transparency: Large short sales of a number of meme stocks also led to market turmoil last January, Gensler said. While FINRA and the exchanges currently publish or make available certain data on short sales, Congress has ordered the SEC under the Dodd-Frank Act to publish rules on aggregate monthly short sales disclosures. In addition, Dodd-Frank has authorized the SEC to increase transparency in the stock lending market. Gensler said he had asked SEC staff to prepare recommendations for the SEC on these issues and whether or not to include total return swaps and other security-based swaps in the news. disclosure requirements.
- Social media: Gensler noted that volatile market conditions in January highlighted the rapidly changing face of social media and its intersection with U.S. financial markets. While acknowledging that online forums can serve as a community, expanding market access and participation, Gensler said he was concerned that criminals would try to use these powerful forums to hype certain stocks or manipulate the steps. “To be clear, I’m not concerned about regular investors exercising their freedom of expression online. I’m more concerned about bad actors who could potentially take advantage of influential platforms.” Gensler said institutional investors with access to machine learning and data analytics could also benefit from insights gained from online communities.
- “Plumbing” market: Liquidation and payment: In January, several brokers decided to restrict clients’ access to trading certain stocks even. Gensler observed that these decisions naturally prompted many questions from the investing public, many of which lost market access at a critical time. Gensler said he has asked staff to carefully review whether brokers are properly communicating their policies and procedures regarding potential trade restrictions; whether the margin requirements and other payment requirements are sufficient; and whether brokers have the appropriate tools to manage their liquidity and risk.
- System-wide risks: Gensler also pointed to system-wide risks, including a company’s lack of liquidity to meet margin calls, several hedge funds that lost a lot of money during the January events and concentration issues, be it among market makers or clearing house brokers.
Gensler said staff plan to issue a report on the matters this summer and that the SEC continues to vigorously examine these events for violations.
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