The Market for Equity Markets: The Classification and Regulation of Automated Trading Systems

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.