The
Market for Equity Markets: The Classification
and Regulation of Automated Trading Systems
Ian Domowitz and Ruben Lee
Abstract
The growth in automated trading systems has been explosive, and
regulatory initiatives and analysis with respect to this new form
of financial market structure quickly followed. We analyze the use
of the definition of an ÒexchangeÓ for the purpose of classification
and regulation of automated trading systems, and the accompanying
statutory distinction between exchanges and brokers who operate
such systems. The definition and this distinction have operated
for over 60 years in the United States, and underpin the entire
fabric of the regulatory structure governing the American securities
markets. We argue that the evolution of the definition, combined
with technological advances in trading system technology, has produced
inconsistencies in regulatory policy, and that the exchange/broker
distinction is no longer viable. Alternative approaches to the regulation
of systems are examined. We propose and analyze a strategy composed
of the separation of the regulation of market structure from the
regulation of other areas of public concern, and the employment
of competition policy to regulate market structure. A central implication
of such an approach is that there should be no distinction in the
regulation of market structure issues between institutions now classified
as exchanges and those that are now classified as broker-operated
trading systems.
Ian Domowitz, Department of Economics, Northwestern
University Ruben Lee, Oxford Finance Group, Oxford, England
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