On The Road To Regulating Automated Trading Systems

On The Road To Regulating Automated Trading Systems

UNIVERSITY PARK, PA - Automation of the trade execution process has transformed the structure of the trading services industry, changing the context within which trade execution services are regulated.

"The economics of automated auction trading are different from those in an era of traditional exchanges, and this is now being realized," says Ian Domowitz, professor of finance at Penn State's Smeal College of Business and immediate past-chair of NASD's Economic Advisory Board.

Domowitz recently co-authored a paper examining the topic, "On the Road to Reg ATS: A Critical History of the Regulation of Automated Trading Systems," with Ruben Lee, Director of the Oxford Finance Group. The goal was to provide a short history of the U.S. equity market experience as a case study of the evolution of regulation in an environment increasingly characterized by revolutionary technology.

"Such a dramatic shift in the landscape of the industry mandates a fresh look at the basis upon which trade execution services are defined and regulated," reveals Domowitz, who is also managing director of electronic market initiatives at ITG, Inc.

Domowitz explains that history shows that a case-by-case approach to regulating automated systems creates contradictions in regulatory policy, as different designs promote different thinking.

"A wider view of the economics of the industry, and the effects of those forces on industrial structure, might better serve the regulatory process," says Domowitz. "Regulation is eventually a matter of law, regardless of the economic view and lawyers depend on language and its use in context. One recommendation that arises from our analysis is that new language be found to deal with the regulation of the automated trading systems."

The co-authors suggest, for example, that the self-regulatory function be divorced from the commercial operations of a market, and run on a for-profit basis.

"If a self regulatory organization markets its services to more than one market, is it really an SRO? If a trading system contracts out its regulatory responsibilities to another party, is regulation now of the 'self regulatory' variety? This issues will continue to grow in importance as the industrial organization of the trading services market evolves both technologically and commercially," says Domowitz.