SEC’s New Order Flow Market Structure Proposals

The U.S. Securities and Exchange Commission is proposing amendments to rules governing stock market order flow execution.

What this means: Additional rules and disclosure requirements for order execution, tick sizes & fees, and order-by-order competition with the goal of making a more transparent trading environment for investors.

The new guidance is currently proposed, meaning it must undergo a lengthy process including public comment before becoming adopted as formal policy.

Here are the major proposals included in the SEC announcement:

1. Additional disclosures: The new proposed rules will expand the scope of the entities that are required to disclose information around order execution. This expansion will include broker-dealers with more than 100,000 customers, single dealer platforms, and entities that operate proposed order-by-order competitions. This amends existing definitions and introduces standardized quality metrics like average time to execution.

See SEC press release and fact sheet.

DFlow Analysis: The SEC’s goal is to improve transparency by allowing individual investors to compare brokers, thereby increasing competition amongst those brokers for user activities. The new proposed disclosure rules give individual investors more information and transparency about execution quality on various trading apps and other execution services. Current guidelines under Rule 605 have not been updated in about 20 years, despite the dramatic change in the nature of trading.

2. Tick sizes and exchange access fees: First, minimum tick sizes would be lowered. Second, access fee caps would be lowered and fees would be made available at time of execution rather than retrospectively. Third, “round lot” and “odd lot” definitions would be revised to include a “best odd lot” order.

See SEC press release and fact sheet.

DFlow Analysis: Currently, many stocks are considered to be “tick-constrained”, and the SEC believes that they cannot be properly priced by market forces. The idea is to lower minimum pricing increments, to improve price discovery for buyers and sellers. These rules also attempt to address increasing competition among liquidity providers based on price, and additionally apply to “all trading”, including OTC. Requiring lower limit fee caps could adversely affect market maker’s willingness to provide liquidity at best prices, given that this could cause rebates to drop.

3. Order competition: The proposed rules create competition on an order-by-order basis for order flow from individual investors. The auctions would last between 100 milliseconds and 300 milliseconds. Orders submitted to auctions must be submitted at no cost to the originator of the segmented orders. Each order must be executed at the best price available at the auction center.

See SEC press release and fact sheet.

DFlow Analysis: The goal of this rule is to prevent orders from being routed to a small group of wholesalers (i.e. current PFOF arrangement), and instead create an environment for wider competition amongst many market participants in an auction facility. Auctions would occur on an order-by-order basis through messages disseminated in consolidated market data.

4. Regulation Best Execution: This proposed rule would put in place a best execution standard. Broker-dealers would be required to establish and adhere to their own written policies meant for execution standard compliance, and self-govern the effectiveness of these policies.

See SEC press release and fact sheet.

DFlow Analysis: The proposed rules are an effort to ensure that broker-dealers are pursuing the best-execution of their customers orders. This best execution standard is likely proposed in order to ensure that broker-dealers navigate and avoid any potential conflict of interest by prioritizing retail customers.

Final thoughts: It remains to be seen whether these proposals will be adopted. As crypto market structure evolves, it is imperative that decentralized finance proactively adopts infrastructure that prioritizes safe, efficient, fair and transparent markets for all investors