The historical practice of stock exchanges providing specialists started on the floor of the New York Stock Exchange in 1872. ((Specialist, Investopedia, http://www.investopedia.com/terms/s/specialist.asp (last visited Feb. 6, 2018).)) Up through the twentieth century, these specialists operated as market makers, ensuring market participants had timely and fair access to trades. ((Id.)) The specialists had an affirmative obligation, in good times and in bad, to provide liquidity to market participants. ((Amber Anand et al., Paying for Market Quality, 44 J. Fin. & Quant. Analysis 1427, 1427 (2009).)) However, due to the prominence of electronic trading, the number of specialists has declined precipitously. In their absence, questions have been raised about whether High Frequency Traders (“HFTs”) should be required to provide market liquidity to traders, since these trading platforms have the ability to transact a high volume of orders at incredibly high speeds. Currently, no such obligation exists.
HFTs account for roughly 55% of the trading volume in U.S. equity markets. ((Rena S. Miller & Gary Shorter, High Frequency Trading: Overview of Recent Developments, Congressional Research Service Report, April 2016, at 1.)) There is a debate over whether the existence of HFTs contributes towards market stability or fragility. On one hand, the presence of HFTs seems to increase liquidity and enhance market functionality by narrowing the bid-ask spread, reducing market volatility, and improving short-term price discovery. ((See Jeffrey G. MacIntosh, High Frequency Traders: Angels or Devils?, C.D. Howe Inst. (2013), https://www.cdhowe.org/sites/default/files/attachments/research_papers/mixed/Commentary_391_0.pdf.)) On the other, questions as to the efficacy of allowing HFTs to conditionally select when and where to play the role of market maker have been raised.
Currently, High Frequency Traders have the option to act in a formal or informal market maker capacity. The “maker-taker” avenue, made available for HFTs who choose to act as formal market makers in exchange for a rebate and information advantages, is one way in which regulators have phased out exchange specialists. ((SEC Staff Memorandum on Maker-Taker Fees on Equities Exchanges (Oct. 20, 2015), http://www.sec.gov/spotlight/emsac/memo-maker-taker-fees-on-equities-exchanges.pdf.)) Yet, this is by no means an even replacement. Without a legal obligation to complete orders in both good times and bad, HFTs retain the discretion to pull their capital during downward spirals, which may delay market corrections. In the same vein, over-reliance on HFTs acting as informal market makers can also cause market instability. A recent study has shown that informal market making has a pronounced deleterious effect on the stock market viability of medium and small cap companies. ((Amber Anand & Kumar Venkataraman, Should Exchanges impose Market Maker obligations?, S.E.C. (2013), https://www.sec.gov/divisions/riskfin/seminar/venkataraman0313.pdf.))
Both the Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”) have taken a concerted interest in HFTs, but have not proposed anything concrete relating to a potential imposition of market maker obligations. ((Rena S. Miller & Gary Shorter, Cong. Research Serv., High Frequency Trading: Overview Of Recent Developments 11 (2016), https://fas.org/sgp/crs/misc/R44443.pdf.)) The literature on the topic suggests that regulators may be tentative in imposing obligations on High Frequency Traders due to fears that increased regulatory pressure will drive them out of the markets completely or cause them to seek alternative forms to operate under, any of which may not furnish markets with liquidity to the extent they do now. ((Peter Gomber et al., High-Frequency Trading, Goethe Universität (2011), https://papers.ssrn.com/sol3/Papers.cfm?abstract_id=1858626.)) Modern day regulators seem to prefer indirect or semi-direct methods of accomplishing market liquidity, tinkering with various incentive structures with the goal of striking an optimal balance between obligations and privileges. ((Stanislav Dolgopolov, Regulating Merchants of Liquidity: Market Making from Crowded Floors to High-Frequency Trading, 18 U. Pa. J. Bus. L. 651, 671-674 (2016).))
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