Searching for a New Center: U.S. Securities Markets in Transition

Maureen O'Hara
Economic Review, Vol. 89, No. 4, 2004

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Technological challenges, governance issues, competitive pressures, and questions about the oversight of trading practices are but a few of the many forces besetting U.S. equity markets. This article outlines some important issues surrounding the evolving structure of the U.S. equity markets and offers some alternative regulatory approaches that might be more consistent with this new competitive environment.

Crafted more than a quarter-century ago in a time of dominant markets interacting with smaller competitors, the National Market System (NMS) was based on a one-size-fits-all approach in which all trade orders were to be treated equally. Over time, technology has enabled the development of new trading systems and dramatically expanded the number of potential competitors. In addition, the traditional market structure of member-owned cooperatives has given way to corporate ownership, which poses challenges for the self-regulatory structure underlying equity market supervision.

Within this new environment, how should markets compete, how should they be linked, and how should they be regulated? To address these questions, the author discusses several pressing issues, such as price-time priority rules, liquidity rebates, tape revenue, pricing increments, and access fees, as well as more general issues such as the viability of self-regulation.

The Securities and Exchange Commission's proposed Regulation NMS is a promising start toward addressing the current market structure's needs. But the author feels that its changes are piecemeal and do not go deep enough to develop a new vision consistent with the current economic realities of equity markets. Where direction is most needed, she concludes, is at the firm level, where regulation must provide oversight to ensure fair and appropriate behavior.

December 2004