May 10, 2000

Public Interest Comment on Issues Related to Market Fragmentation

  • Jerry Ellig

    Research Professor, George Washington University Regulatory Studies Center
Key materials
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The SEC is seeking comment on their concerned that customer limit orders and dealer quotes may be isolated from full interaction with other buying and selling interest in today’s markets.

Summary

The Securities and Exchange Commission (SEC) is concerned that when the same security trades in multiple locations, "market fragmentation" might prevent investors from getting the best possible terms of trade. However, to the extent that fragmentation poses problems, they are government-created, and would not be solved with additional regulations, centrally mandated linkages, or uniform and cumbersome disclosure systems. There is little evidence that the problems the Commission fears from fragmentation are significant. Some alleged sources of fragmentation, such as internalization and payment for order flow, also possess offsetting benefits, because they allow brokerages to lower trading costs for themselves and their customers. Far from creating "fragmentation," competition among market centers and market participants encourages low trading costs, price discovery, transparency, market efficiency and innovation.

Market centers have incentives to promote their competitive advantages in execution and order processing in order to increase trading volume. In a competitive environment, investors will be able to choose the market centers or other execution venues that provide them with the combination of features that best meets their demands. Over time, as investors converge upon the most liquid market centers that satisfy their demands at the lowest cost, markets will become less fragmented and more efficient.

The comment concludes that none of the regulatory changes in the Request for Comments are justified. Instead, the Commission could better serve investors by promoting competition in market data provision and market-based trading linkages among market centers.