Net Neutrality And Modern Exchanges

A great victory was won earlier this year for supporters of innovation, competition and openness — net neutrality rules were adopted by the FCC. Those rules have recently come into effect, and we’ve already seen significant movement, including the $100 million AT&T fine for data throttling.

I’ve been on the Internet since 1993, and on the web since NCSA released Mosaic. For me, open systems, transparency and open source movements are the preference. We have seen remarkable and unbelievable technological progress because of it — from the protocols that form the foundation of the Internet itself, to Linux, Android, MySQL, PHP and so many other open source projects. The FCC recognized the critical importance of such openness in issuing the Net Neutrality Rules:

It’s critical to recognize ISPs as the gatekeepers of the Internet, who therefore should have the added responsibility of operating in the best interest of all Internet users, not just the richest and most powerful. While I am excited to see such recognition on the part of regulators as it relates to the Internet, it is troubling to not see the same logic extended to financial services.

I can’t help but look at what has happened in financial services and spot the same warning signs that made the net neutrality movement so pressing. At its core, net neutrality was about ensuring a level playing field for all users. In financial services, stock exchanges serve as the gatekeepers, swapping billions of dollars’ worth of data, technology and rebates with the wealthiest and most sophisticated players. Clearly not a level playing field.

There can be no doubt that advances in electronic trading and broad technology adoption have facilitated access to markets that would have been unthinkable 30 years ago. There are clear parallels with the technological advances and broadband adoption that have brought the Internet to every corner of the world, and high-speed access to most American households. This cheap access to financial markets is the first citation a defender of the status quo will make.

The question is not whether financial markets are more open than they were 30 years ago, the question is whether the financial markets are as fair as they could be for all participants. The simple answer is: No.

Market data is one excellent example where the current regulatory structure creates mini-monopolies, which I recently discussed in a presentation to the SEC, and on which the famous NetCoalition case centers. Between market data costs, connectivity, co-location and network and infrastructure investment, modern stock exchanges and the regulatory framework that protects them have created a world of haves and have-nots, whereby those able to invest massive amounts of money have a structural advantage over those who cannot.

Yet another example is the latency disparity between high-speed proprietary data feeds and the Securities Information Processor (SIP). Conveniently, both of these feeds are sold by exchanges, NYSE and NASDAQ being responsible for the SIP, and all exchanges offering high-speed proprietary data feeds. The SIP is the public data feed — the prices you see scrolling along the bottom on CNBC, for example. It is the official record of prices and trades, and held in a position of regulatory primacy.

However, exchanges created proprietary feeds — which contain even more information (i.e., depth of book), but most importantly, the direct feeds are much faster than the SIP. The stock exchanges created a virtual “fast-lane,” which is analogous to telecommunications companies looking to sell faster and better services to those willing to pay the highest price.

There is no excuse for a speed differential between these services, and people were rightly outraged by the prospect of slower Netflix. Now that a comparable structure affects our 401ks and investments, we need to summon that same outrage and apply the same degree of accountability to culpable exchanges as we did to ISPs.

A utility should avoid agendas which diminish its ability to serve all beneficiaries effectively.

High-speed trading firms (often referred to as high-frequency trading, or HFT) seek every possible millisecond and microsecond of advantage. They pay exorbitant fees for these proprietary feeds, and even crazier amounts of money for high-speed telecommunications lines between cities and data centers. This forces other firms to pay these same expenses to fight a losing battle to maintain technological equivalency.

NYSE and NASDAQ are now even selling microwave access to shave microseconds, millionths of a second, for their highest-speed clients. It makes no sense; there has never been a conclusive demonstration that latency reduction at this scale improves market quality for investors.

This is one of many examples of societal waste that can arise when the incentives of critical gatekeepers are not aligned with the public interest. A utility should avoid agendas which diminish its ability to serve all beneficiaries effectively.

Of course, it’s easier to be incensed when the Internet goes awry, because it affects people in their home, on their TVs and computer screens. The problem is easier to ignore — and discussed less — when a distorted playing field is only visible on a trader’s screens. And our ambivalence gives the exchanges a get-out-of-jail-free card.

As public companies, NYSE and NASDAQ have lost sight of who they are supposed to serve — their own shareholders or the shareholders of the thousands of publicly traded companies that list on either exchange.

This conflict is accelerated by exchanges being granted self-regulatory status (they regulate themselves!), which has been criticized by market participants, SEC staff and commissioners, and Congressional members and aides. Imagine if AT&T or Verizon were allowed to write the regulatory rules by which they operate and police themselves when there are problems.

Since a fortuitous event in 2012 when the story of why I left high-frequency trading was aired on NPR’s Marketplace, I’ve had the good fortune of working with disruptors throughout the industry. I’ve appeared before the U.S. Senate, SEC and CFTC, and at every opportunity have advocated for an open, transparent approach to the measurement and regulation of market structure.

This has culminated in the founding of a coalition of large asset managers pushing hard for a transformation in the level of openness and transparency in our industry — the Healthy Markets Association. At Healthy Markets we believe that a dramatic shift in the level of transparency is a necessary starting point for reforming the financial service industry — that it is the only answer for such deep-seated conflicts of interest.

While conflicts of interest are generally difficult to eliminate, it is critical to reduce them to provide the level playing field that ensures investors are being accorded the same level of respect and access as even the most sophisticated market participants.

The net neutrality victory was a tremendous one for the technology industry. Regulatory reform is also needed in financial services, and as gatekeepers of the market, exchanges must be the focus if we hope to create and sustain a level playing field and ensure efficient markets.