August 21, 2012

Recent headline-grabbing technology missteps, including Knight Capital and Facebook's IPO on Nasdaq, are causing market structure confidence in the capital markets to slip, with only two percent of industry participants rating their confidence as very high, according to the most recent US Equity Market Structure Confidence Survey (registration required) from TABB Group, a New York-based financial markets' research and strategic advisory firm.

When the survey was first taken in May 2010, shortly following the Flash Crash, 12% of respondents indicated their confidence in equity market structure was very high. In June 2012, following Nasdaq OMX's blunder of the Facebook IPO, confidence dropped to 5%. Today, it stands at 2%, according to the survey of 260 market participants.

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Market Structure Confidence, 2010-2012

"Following the Flash Crash and the IPO fiasco, [Knight] is another illustration of the flaws in the US equity market structure," Adam Sussman, a partner and director of research at Tabb Group and author of the report, said when the survey was launched in early August. "It's not that a lot of investors outside of Knight were damaged. But the incident does more damage to US equities as a brand. This incident, on top of the previous ones, chips away at the US exchange-traded markets as a safe place to trade."

Among the survey participants, the buy side is the least confident in current market structure with 50% confessing to a weak or very weak confidence level. "The buy side has long been unsatisfied with the amount of transparency into order routing practices among broker/dealers and the venue selection process within smart order routers," writes Sussman. "More recently, they have been concerned about the impact of ETFs and other index trading products on single stock liquidity."

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Market Structure Confidence August 2012, By Firm Type

Not surprisingly, execution venues has the highest opinion when it came to market structure, with 46% indicating they had very high or high confidence in market structure. Broker/Dealers had the second highest confidence level when it came to market structure confidence, with 36% indicating very high or high.

However, despite the timing of the survey, respondents indicated the Knight Capital incident would likely have little impact on overall market structure confidence. Many respondents said that the Knight Capital incident was not a market structure issue at all. Instead, participants felt that Knight's problems were a lack of internal controls. In fact, the Facebook IPO and the Flash Crash have had larger and longer term impacts on confidence, according to the report. "More people believe that the [Knight] incident had a minimal impact than a significant impact, but very few believe it had no impact at all," writes Sussman. "Then, when asked which event had the greatest long-term impact on overall retail confidence Knight barely ranked."

[For more initial "snap" reactions to the Knight Capital trading incident, read Knight Capital Sets Twittersphere Afire, Just After #Knight Burns Itself.]

Moving forward, survey participants indicated they want regulatory action, following the many technology issues that have damaged the marketplace during the past year. According to Sussman, the willingness to consider new regulation is a shift from previous surveys. "When it comes to regulators, the mantra seems to be 'sooner rather than later,' he writes. "After the

Flash Crash, folks were worried about the unintended consequences of regulations. Now, in the context of protecting the markets from further technology glitches, participants want action."

And respondents want action quickly, with 56% of broker dealers looking for regulators to take action extremely fast (1-3 months) or very fast (3-6 months). The percentage of buy side respondents wanting swift action was even higher, with 66% looking for extremely fast of very fast regulatory action. However exchanges/ATS aren't as eager to receive new rules or oversight, with only 31% indicating extremely fast of very fast regulatory action is required.

When it comes to the type of action that regulators should take, the overwhelming response is that fragmentation should be reduced. The TABB survey found that 30% of broker/dealers, 38% of exchanges and 36% of asset managers indicated that a reduction in fragmentation would help the marketplace. A financial transaction tax, was the least popular solution, with 8% of broker/dealers, 7% of exchanges and 3% of asset managers thinking a tax would be beneficial.

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What new market structure regulations would help minimize the types of events we have seen in 2012 or, more broadly, help the industry regain the trust of investors?
ABOUT THE AUTHOR
Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology.