Reg NMS in the spotlight amid HFT criticism

Author: Zoe Thomas | Published: 14 May 2014
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As regulators focus on the practices of high-frequency trading (HFT) in Europe and the US, the rule which led to the creation of the industry continues to be debated.

Regulation National Market System (Reg NMS), that gave traders insight into other investors’ trading strategies, was originally intended to correct problems raised in the 1987 crash when brokers refused to answer phones to avoid placing orders to sell.

When the rule was passed in 2005 in a three to two vote, the dissenting Securities and Exchange Commission (SEC) commissioners expressed concerns that it could create anti-competitive behaviour. They drew particular attention to the trade-through aspect of the law, which requires orders to be executed at the best price regardless of what exchange the securities are listed on.

Trade-through has been accused of allowing HFT to front run, by giving high-speed traders a chance to see larger investors’ orders on one market and then race ahead to other exchange to purchase shares of the same stock and sell them back to that investor at a high price.

Opposition to the rule lingers today. "It’s not fundamentally necessary to have a rule that people trade on any exchange," said Steven Lofchie, partner at Cadwalader Wickersham and Taft.

"One alternative possibility is simply requiring broker-dealers be responsible to provide best execution and letting broker-dealers decide the mechanisms around how they do that."


Concerns that Regulation NMS would encourage anti-competitive behaviour were raised in the dissent when the rule was passed in 2005;

The regulation has increased high frequency traders’ ability to arbitrage using fragmentations in the market created by the increased number of exchanges


Reg NMS effectively opened the US exchanges to greater competition, spawning the creation of new trading platforms.

Many in the industry defend the rule, arguing that it achieved its intention: to create competition between the exchanges. "We had a Duopoly between NYSE and NSDAQ. Reg NMS was a conscious decision by the regulators to break that duopoly," said John Adam, global head of product development at Portware, a trading technology provider.

This fragmented market made latency arbitrage possible, giving traders the ability to profit from a difference in price between exchanges for only milliseconds. It has become a standard tool for high-frequency traders.

"Reg NMS did exactly what it was intended to do, create competition between the exchanges"

While computerised trading was already an element of the market when the rule was created, trading speeds were not as fast or a much of a concern.

Public scrutiny

HFT has become the focus of public scrutiny following release of the book "Flash Boys" by Michael Lewis. Regulators have been looking into issues created by Reg NMS and HFT, but are now facing greater outside pressure to act.

"My concern is if this becomes a political problem that Congress attempts to solve, it’s hard to see how it will be beneficial for the market," said Keith Ross, CEO at PDQ Enterprises, LLC, an equities market venue.

So far the current SEC commissioners, none of who voted on Reg NMS, have taken a less reactionary approach, but it is yet unclear if any new regulation will consider the information that was overlooked in 2005.