The Latest Developments in U.S. Equity Market Structure

Reid Noch:
So as retail investors continue searching for their next big lotto tickets, perhaps have quickly joined the rank of ZODT options, levered ETFs, and prediction markets where they make up over 80% of notional crypto volumes.
Peter Haynes:
Welcome to TD Securities podcast series, Bid Out: A Market Structure Perspective from North of 49. My name is Peter Haynes, and today for episode 84, we will discuss the latest developments in US market structure, a topic that we last covered in March following two round tables on potential reforms to Reg NMS and the need for the order protection rule. We will dive into that topic now that a formal OPR rule proposal is on the docket, and we'll also hit on several other hot buttons in market structure over the next 45 or so minutes. Joining me for this discussion are two market structure heavyweights.
Representing TD Securities in the left corner and hailing from Naples, Florida is Reid Noch, our US market structure expert. And in the right corner, hailing from Philadelphia, PA where they're known to boo Santa Claus is Zak Goodwin, equity trader for CPP Investment Board in Toronto.
Zak and Reid, thanks for joining me today for the discussion.
Zak Goodwin:
Thank you so much for having me. First off, just want to say thank you. I've been a long time fan and a listener, so glad to be on here. And next I just want to clarify on the Santa Claus statement. That was a pretty raggedy Santa Claus. And from what I've heard, that Santa Claus was actually pulled out of the stands because the other didn't show on time. And that was coming from a 2 in 11 season. So he happened to get booed that day, and I think he should have been booed. So that's just the way the cookie crumbled. And also speaking of those high expectations, I've trusted the process for long enough, and we have LeBron in Philly now, so there should be an NBA championship coming home.
Peter Haynes:
Yeah. It just sounded like excuses, Reid. Typical Philadelphia sports fans making excuses why they could boost Santa Claus. In all seriousness, Zak, tell our audience a little bit about how a young man from Philadelphia ended up in Toronto. And what are the three biggest surprises you have about living and working in Toronto?
Zak Goodwin:
It was really a multitude of things that lined up really well. And if you would've asked me a couple years prior, it was not on my bingo card that I would've ended up in Toronto, but was ready to try something new. And then I did know my current boss prior to the move here, and she had recently started at CPP, so that certainly helped. I knew Toronto was really an amazing city. And after doing a little bit of research, was pretty fascinated by the Maple A complex. And have to be honest, I did not know that much prior, but after doing some research, was super interested and packed my bags and off I went.
In terms of the biggest surprises from the city, I'll say first off, the winter was a bit brutal for me. Growing up in Pennsylvania, I thought that I was prepped and ready to do this. And then you have that kind of negative 20 Celsius feel with the wind and it just really hits different. So that was very different. But outside of that, I would say that it's super diverse and the amazing restaurant, bars, events and things. I've really just loved experiencing that, especially in the summer here. And then lastly, I would say just the whole Bay Street dynamic, how tight-knit of a community it is, how everyone kind of embraces each other and knows each other is fantastic, and it's something I really enjoyed. So I'd say those are the kind of main things that have immediately stuck out about the city.
Peter Haynes:
On the third point, I would say that a lot of folks from outside Toronto in the financial industry think that the Bay Street community is too tight and they're not used to a collegial environment where everybody's not at each other's throats. We compete very, very hard with our other brethren and you compete in some ways with the other pension funds. But at the end of the day, I think we all try to get along a little bit here. What were you going to say, Reid?
Reid Noch:
I was going to say Celsius, they got to you.
Peter Haynes:
Yeah, that's exactly right.
Zak Goodwin:
I still don't know the conversion, but I figured I would drop a Celsius stat for all the listeners.
Peter Haynes:
All right. Well, that's good because Reid grew up in a town where the Celsius degrees currently are about 30. And I'll let Reid try and figure out what that is in Fahrenheit, what he's used to. But Reid, you came from Naples, you've been to TD Securities for a few years. Tell us a little bit more about your background and what is it about equity market structure that you find so interesting?
Reid Noch:
So I started my career at RBC in New York in 2021, right in the middle of the pandemic. I came in as a desk assistant before I even graduated just because everyone was so busy with volumes of volatility, with the idea I'd go into quantitative or sales trading. Once I got there, I kept working closely with the head of market structure at RBC at the time, Rich Steiner, who is an incredible mentor. After a few months, Rich, my boss at the time, asked me to join his team full-time, which was amazing. I viewed that as a mentorship or apprenticeship where Rich walked me through the different venues, regulations, macro trends, and how they fit together. He left to run electronic trading at Piper. I took over a year, and then after that moved to TD.
What I love about market structure is how dynamic it is. One day you're just analyzing a specific order type and how it impacts a parent ticket. And then the next you're talking to a fund on some regulatory overhaul that impacts their entire business model. So there's always something to talk about and something to look at.
Peter Haynes:
And throwing on top of that, Reid, I always say this about the equity market is that there's so many different symbols and there's always a story happening every day. And then you take it to the micro level on individual orders and order types and the like. And I find that part fascinating. Zak, we'd be remiss if we didn't make sure everybody understood that your previous tour of duty was with BlackRock, both in San Francisco and in Atlanta, and that you had the pleasure of working for our now colleague, Brent Hicks. He was your boss. Maybe you could tell us a story about Brent. You got any dirt on him?
Zak Goodwin:
For my own lobby, I won't drop any Brent Hicks stories, but I will say I learned a ton at my time there and was the best place I could have possibly started my career. But just all the kind of managers team that I had there were phenomenal and it was sad to leave, but this opportunity really stuck out to me and built on a lot of the knowledge that I learned there. So definitely shout out to that entire crew and only obviously wish those guys the best.
Peter Haynes:
And we're going to dig in on some of the things that sitting in a chair like the one you're in now or the one you were in at BlackRock, just seeing so many different aspects of the equity market and now at CPP, getting to see so many different regions. We'll touch on that as we get on a little bit. So Reid, let's dig in here on some of the latest developments in the US, and I want to start with the order protection rule.
In June, the SEC formally proposed the elimination of Rule 611, which is known as the order protection rule or the trade-through rule as some people call it. The rule first enacted in the US in 2005 requires participants to always get the best visible price on an exchange before trading at a worst price elsewhere. This latest proposal suggests there is no more need for this rule.
Do you agree with participants that suggest Rule 611 is past its best before date? And what are the important devil's details in this rule proposal that investors need to note?
Reid Noch:
It's a tricky question. Jim Angel, market structure professor and expert from my alma mater, Georgetown, described the order protection rule at the first round table as scaffolding that helped modernize the market, but now is no longer necessary. There's strong arguments for keeping it because the system works so well today. That said, there are clear areas for improvement. Brokers should not necessarily have to connect to every small exchange of no differentiation beyond just fees and rebate structure. And there's definitely much more flexibility for block orders that could be beneficial. To me, the most important part of the proposal is replacing a pretty prescriptive execution standard with an updated FINRA Best X framework. At the SEC open meeting on the topic, the commission suggests firms could evaluate Best X using a range of factors, child order price, parent order performance, instant settlement, markouts, and others. The challenge is when brokers can point to any number of factors to justify Best X, they aren't really accountable to any standard.
So that puts a lot more responsibility on the buy side, especially smaller firms to define and measure their performance. This gets trickier too in a post-OPR world as the MBBO may lose its position as a benchmark altogether.
Peter Haynes:
So Reid, in the proposal, the actual rule proposal, I mean, Rule 611 starts at 600 and works all the way up to I think 612. I think there's 12 different rules. And what is included other than Rule 611 in this proposal? I know a lot of people said that everything needs to be on the table, but what is included? And importantly, what's not included in this proposal?
Reid Noch:
The largest portion I would say included is locked and crossed markets. I don't have the numbers memorized off the top of my head besides 611, but that was specifically addressed. And then I will say also, I think Rule 610, which is the access fee cap, was addressed. And because the SEC still wants some sort of MBBO, and they do acknowledge that there needs to be an access fee cap for that to really be meaningful or just alone, the pricing could cause lock and cross markets, especially as every exchange pushes up to the 30 mil fee cap today. So I think those are the areas addressed.
Peter Haynes:
We keep an access fee cap that was put in place specifically because we had OPR in 2005. Aren't there going to be people like exchanges that will say, "Why are we still having an access fee cap if we don't have OPR anymore?" How do we circle that square?
Reid Noch:
The exchanges have a really good argument and are very much pushing back on that aspect of it. The only reason why we have that access fee cap is that you're required to hit those venues. You can see in off-exchange venues, there's some that are charging 50 mils, and that's fine because you don't have to go there. If you don't have to go to an exchange quote, good chance that they do successfully get rid of that. So I think there's a push to allow exchanges to quote in any prices they want, but for something to make the MBBO, it has to be an SRO with an access fee cap and working with CFMA right now on trying to define what we believe what should be in this future MBBO, because part of the proposal is getting rid of automated quotations. It'd be insane to have a manual quote be part of the MBBO and take over a minute to access it.
Peter Haynes:
Would be back to the years before 2005, which is why that rule was put in place in the first place. There are some unintended consequences if you get rid of access fees, and maybe we can touch on that a little bit later. So Zak, the impetus behind Reg NMS, as I mentioned just a second ago, was really just to force the NYSC to allow its quotes to become accessible immediately. There used to be the 30-second delays. There was always an excuse as to why an order wasn't filled that you could see on the NYSC. And the result ultimately after NMS came in place, which I guess Chair Atkins, why he dissented was partly because this is how it played out. The result was there was significant fragmentation of order flow and volume traded across a whole lot of different markets, as well as the market construct, became in favor of the fastest participants.
So in response, brokers and other intermediaries have developed tools that will neutralize the speed benefit. I'm curious, Zak, in your opinion, are the tools that have been created good enough to protect your order flow from leakage to these speed arbs? And can you actually see a noticeable difference in execution outcomes from different brokers based on their routing table decisions?
Zak Goodwin:
Yeah, that's a great question. And I think Reg NMS definitely increased competition and improved access to display liquidity, but also with that, as you noted, fragmented the market and made speed a massive part of execution. Brokers have obviously responded by building much smarter routing logic. We 100% do see a difference across different counterparties. And this ranges from all the different things they're doing within those algos, whether it's anti-gaming, toxicity scores, conditional and midpoint books, segmented dark liquidity, randomized routing, order slicing, all these different things to really reduce predictability and information leakage. And as you said, the goal for us is really to avoid signaling intent to the fast guys so they're not stepping in front of our orders.
So we 100% do see a difference. And I would say one of the beautiful parts about working at CBP or working at a pension in general is there's not a ton of times where we are really trying to move super fast. So we love a lot of the developments around in the clean dark realm where you're seeing a lot of brokers go now and where they're really ranking these venues by toxicity. And the quality of liquidity is really what's important to us most of the time instead of just quantity. So I do think a lot of those tools close the gap, but they're not a complete solution. Execution quality still depends on that broker's routing philosophy, venue selection, and how they adapt to current market conditions. So as I said, we do see those differences, especially on larger or more difficult orders, even if they're not always dramatic. So that's why we spend a lot of time looking at TCA and not just fill rates, but implementation shortfall, market impact, adverse selection, post-trade price movements, all those things to really put the pieces together to see who is making the best routing decisions.
And I think to that point, when we're thinking about large orders, a little off-topic, but one thing we're talking a lot about market structure and electronic markets. But I will say one thing that we've really leaned into is working on those bigger orders, working with high-touch desks, leaning into and nurturing those stronger relationships to be able to lean on our sell-side partners on those bigger tickets to find natural liquidity or to use a Reg M type trade or other creative solutions to get us there just because the answer isn't always in the pipes, in darks or things like that. So I think it's a push and pull, but it's something that we definitely spend a ton of time on.
Peter Haynes:
Well, you used the word predictable as it is the key to any buy-side trader's success is to avoid being predictable and avoid being part of a routine. With that said, let's talk a little bit about how execution strategies for those outsized orders, which you say you're now working a little bit more with the sell side high touch desks, how that has evolved overall in your pad over the years. And I'm thinking about where you find liquidity. Do you think liquidity in the market is harder to find today than it was say 10 years ago? And also you have to think about the impact of retail investors and how they have changed liquidity and they may be a little bit more hard to access. You've got less displayed liquidity. I'm curious how you put that whole thing together and decide how to change your execution strategies going forward, and is the environment today better or worse than it was five or 10 years ago?
Zak Goodwin:
I can't go back 10 years. I wasn't trading at that point. But I will say that what we put a lot of focus on is just looking at current market conditions along with the order size and how we're going to treat those orders. So we're looking a lot of times at things like top-of-book liquidity, just general across different indexes, what the cost of trading is doing from a week-to-week perspective. In a certain book, are we crossing spread more times than we need to? All those different things are really what we're looking at from a day-to-day perspective to choose our outcomes. And then we lean into things like, okay, on our VWOPs, do we need to drop our participation in a certain domain or a certain sector? And tweak our wheel to deal with certain counterparties or others or ones that have higher trajectory crossing rates and things like that.
So I wouldn't say we're looking back five years and thinking, wow, it's way harder to trade. Obviously the fragmentation and the amount of trades that are happening in darks off exchange altogether and then liquidity to the close. You can't ignore all of that, but we try to look from a month to month, week to week, how can we be as dynamic as possible? And that ranges from making small tweaks in our wheels or things of that nature, all the way to maybe transitioning a certain book that we used to trade in algos to trade more with high-touch counterparties that we may want to move faster on or things like that.
Peter Haynes:
There's a lot to consider there and markets are, as we all know, getting more complex. And we're going to talk about some of those changing complexities in the next few questions here. Let's start with NMS. I want to go back there for a quick second, Reid. Now that we have that proposal and it's been germinating for a couple of months, what are the key market implications that investors should be thinking about in the event OPR is eliminated? I know you mentioned the MBBO. I want to dig in a little bit more. And what have you seen from the commentary and comment letters to date?
Reid Noch:
So a lot still depends on the final rule and some of the broader debates around it, including the access fee caps and whether even exchanges retain their SRO status. Drawing implications, I think it's important to look beyond the immediate impact and ask what the markets could look like a year or two out after OPR is removed. On day one, it's unlikely much would change, but over time I could see SDP IOIs becoming much more important and large workflows beginning to shift.
Peter Haynes:
Can we just define that for our listeners, STP IOIs? What exactly do you mean by that?
Reid Noch:
So STP IOIs are usually with a market maker or banks like Central Risk Book. You can think of them as quotes, but they're actionable IOIs streamed directly to a participant, a broker, or a buy side directly. And that is in response to potentially information leakage on trying to blind ping a market maker venue for a request for quote, because you're giving up information without getting anything in return. So IOIs are much more accountable and you can hold the market maker participant usually much more accountable to it because you know exactly who it went to and the markouts and everything. You can measure it or if they fall down, you can see that as well.
Peter Haynes:
Zak, are you guys keen users of actionable IOIs? And is that becoming a bigger part of your workflow in the last couple of years?
Zak Goodwin:
I would say that we are more in the discussion phase, not something... I know our EMEA desk was looking at it quite a bit and have traded on them, but I think from our perspective, we are more in the kind of conversation phase of what that looks like, is it right for us? And just figuring out the right use case where those kind of actionable IOIs fit into our strategies. So I would say nothing imminent, but it's something that you can't really ignore at this point.
Peter Haynes:
Okay. So Reid, let's come back to the MBBO. What does the MBBO look like in a post OPR, it doesn't exist anymore? And have you seen anything in the comment letters that have come into the SEC so far that gives you a sense of the type of feedback they're going to receive on this proposal?
Reid Noch:
So what the MBBO would look like, I think it's still very much up in the air and with debates. So the SEC seems adamant that only SROs can contribute to the MBBO, but the FINRA ADF will be live. And with no automated quote definitions or areas, almost anything then can [inaudible 00:19:37] and would be part of the MBBO. There'd probably be some access fee cap or the SEC is proposing an access fee cap, but still huge if there's asymmetric speed bumps or if they're manual quotes or instant settlement on a tokenized venue. The SEC, I think in early conversations seems like they still want to include potentially tokenized venues, part of it. That all has huge effects on the relevance of it. Same thing still with order size and round lot sizes, especially if there is no protected quote. Does everything just move now to one share essentially? Or is that the area?
And with different areas, if it's locked or crossed, what does it mean? I think you could see potentially post-trade transparency be much more used as a benchmark and what prices are traded instead of having different areas block trades be benchmarked to midpoint or MBBO to some sort of trailing VWOP.
Regarding the comments, so we still have about 30 days for the comment period file is open till. And so people usually file at the end of that. So there's very few comments currently in right now and very little insight you can glean. Just checked earlier today.
Peter Haynes:
You mentioned access fees and the SEC actually has a rule that was supposed to go into effect in November that would cap access fees at 10 cents per hundred shares where today they're 30. And also to reduce tick sizes to half a cent for, I don't know, something like 1,800 stocks. Where is that file right now in light of the OPR rule? And I feel like, and correct me if I'm wrong, there hasn't been as much chatter about equity tokenization in the last little while versus what we were hearing maybe six months ago. What do you think on that?
Reid Noch:
Great question. So with the access fee caps, I think they're very much tied to OPR. And so as the industry's debating OPR, just because you have to go to a venue, the access fee cap exists. If it goes away, there's a strong argument that that cap should go away with it. And so the SEC kicks the can down the road and implementation date to next November. So November 2027 is a good chance they delay it again, especially if they're appealing OPR. The tick sizes are more tied, I think, to the access fee part of it, not necessarily the MBBO, as you can't really have a fee worth more than half the quoted spread without materially distorting markets. So I think that's why those two are so heavily correlated.
And then on the tokenization front, I think it's been quieter because the agencies didn't want to disrupt the clarity debate happening in Congress. Now that that legislation has appeared to be stalled and won't go through, we can expect the SEC and the CFDC to begin picking up that issue again and soon coming up with new guidance or rules earliest this month.
Peter Haynes:
Okay, Reid, let's switch gears to 24-hour trading. Another topic that's getting a lot of attention. To level set, the US exchanges will add an overnight session from 9:00 PM to 4:00 AM starting in December. And that'll mean that quotes will now be available to the masses through the Security Information Process, or SIP as it's known, for 23 hours per day, five days a week. So far in response, we've seen the LSE announce its plans to go to 24-hour trading in early 2027 and other global exchange executives have been musing about it. In Canada, the TMX appears to be taking a wait and see approach after surveying its users. And so we'll see where they end up, but at this point does not appear that TMX has plans to go to 24 hours. Reid, can you tell us the need to know facts about extended hours?
Reid Noch:
So similar to today, there's no order protection outside of core market hours. The listing exchanges will still conduct surveillance, but there generally won't be trading halts outside of corporate actions. Instead of limit up, limit, down pauses, the overnight session will initially use 20% price bans in either direction. Those bans will be based on a reference price that incorporates the official closing price as well as the last round lot trade at 7:45 PM Eastern Time. I'll say the exchanges and the SIPs will work 23 hours a day, but overnight ATSs will remain open during that 8:00 to 9:00 PM window, which historically is the busiest hour for the overnight session. Then those same overnight ATSs are looking to cover the weekend shift as early as December 6th. So we're potentially moving to a 24/7 environment much sooner than later.
Peter Haynes:
Reid, who wants this to happen?
Reid Noch:
The people driving this is solely retail, more international retail too. I know if you talked about Peter, that you said it's the thrill of the fill where retail wants it right away. But when retail now is over 20% of US equity volumes and in any given name, like Tesla could be as high as 40, 60% a day. And then a meme event like we saw with Allbirds earlier this year. I think it was 98, 99% retail. It's kind of hard for institutions to ignore if that becomes their go-to, especially if this is one time that institutions can interact with retail. And then for episodic events, only just one tweet away where everyone gets called back or someone has to do something.
Peter Haynes:
Well, you're right. There's a point in time when there's so much activity happening, even if it's meme oriented in a name that maybe Zak's organization happens to be trafficking in. So Zak, I know, and it was in the last few years, and you would've heard about this sure through the BlackRock channels, that there was a push for an even shorter trading day, not a longer trading day. We saw that in the UK. And then more recently there's been continues to be chatter that market liquidity is spread out over too long of a period. So that leads to the question, what do you think, Zak, will be the longer term implications of essentially a 24-hour trading day? And I'm curious, does CPP traffic currently in pre and post-market activity? And if so, are you using broker algos or held orders or how are you accessing that liquidity?
Zak Goodwin:
I'll start off by saying that every time we have a market structure conversation, someone comes in, they're like, "Oh, do you want to talk 24-hour trading?" I'm like, "No, I've talked about it enough." I think every single buy-side trader that you talk to, you're going to get the same answer that they are not super fired up about 24-hour trading, but still I digress. And I think just because the market is open doesn't mean there's enough liquidity to execute efficiently. My concern is that we're solving for access, but before we've really solved for liquidity. So right now you already see the overnight fragmentation and ATSs like Blue Ocean, broker internalization, and like Reid mentioned, some of the exchanges getting up and running. And I don't think those just moving that flow onto exchange changes the economics overnight.
The SIP is obviously a major step forward to have a consolidated quote. That's a prequisite for institutional participation, but it only really solves one piece of the puzzle. You still need market makers willing to commit capital, clearing and settlement processes that make things run seamlessly, securities lending, corporate actions, surveillance, all these things. And spreads will stay wide, in my opinion. Display depth will probably be thin, and the true cost of execution remains materially high at this time or higher than normal trading hours. So long-term, I think the overnight trading becomes another tool rather than really replacing anything that's happening within the regular trading session. And it'll be used for event-driven trades, managing risk around macro events, things of that nature.
Peter Haynes:
Let me ask you the question more directly towards CPP. If XYZ stock reports at 405 and there's a whole ton of volume because something material came out in the earnings, would CPP potentially access liquidity in that name if it was something you were trafficking in that day?
Zak Goodwin:
Yeah, so that was my next point that I was jumping to, and it's really right. CPP's trading in the pre and post from an equity trading perspective very infrequently. I think the example that you gave, once in a rare while, we may have a PM that wants to tweak their positioning into a pre-market print or post-close after something comes out. They may want to trim. I think I can count on one hand the amount of times we've done that since I've been here. So it's not something that we're doing super frequently. And to access that liquidity, we'll generally go to a desk just because of how infrequently we do it. I know we can access via algo or via a broker's order router. But generally for us, we'll reach out to a broker and just give them our instructions and have them handhold it, especially just with proliferation of some of the algos that are happening in the pre and post that can be, in my opinion, a bit predatory. So we tend to work with the desk from that perspective.
And I think lastly, I'll just say that, again, these are my views, not CPP, but aside from the staffing and technology complexities, Reid was talking a little bit about retail. And I think that's the biggest thing to me is that it feels like this is another development where even if retail does get what they want, it could be another situation where they're ultimately caught holding the bag. So it'll be interesting to see how this continues to develop.
Peter Haynes:
Zak, on that exact point, Reid mentioned a line that I do like to use, which is the fill is the thrill for the retail investor. But I also want to come back to what I've now really kind of lasered into my brain was what Justin Hughes said on our pod a few months ago where for retail, it's a convenience tax and they're willing to pay it. Being able to trade at 10:00 at night with a couple Chardonnays. That is a convenience tax. They're willing to pay. And if they're willing to pay it, then so be it. I'm going to stop worrying about the issue that it's three or four times bid-ask spreads in the middle of the night and it's the direction of travel. So buyer beware.
So Reid, it's no secret that another issue that's been concerning about retail is leverage. And it's a theme in equity markets that is colliding these days with market structure that's evolving from the crypto landscape. Specifically, I'm thinking about what is known as perps. Can you explain where perps came from and have they become a leveraged vehicle for equity investors?
Reid Noch:
So perps are perpetual futures or future contracts that never expire. Instead of rolling into a new contract, they use a funding rate often based on a eight-hour weighted average paid hourly where longs pay shorts or vice versa, depending on the relationship between the contract price, the reference price, and the overall demand associated with it. They are typically associated with very high degrees of leverage. So 20 to 50 times is usually what you see on most contracts overseas, and we've seen as high as 500 times leverage. And so as retail investors continue searching for their next big lotto ticket, perps have quickly joined the rank of ZoDT options, levered ETFs and prediction markets where they make up over 80% of notional crypto volumes, and that's Bitcoin, Ethereum, tokenized stocks, tokenized commodities. And just in the past about six months, we've seen a big shift from Bitcoin, Ethereum, and mostly meme coins into tokenized ETFs and tokenized stocks and securities on these overseat platforms, gaining hundreds of millions of dollars of notional trading a day.
Peter Haynes:
Reid, do you think if we look back on equity market structure and how it evolved, that if it was able to do a do-over, e-minis and other financial derivatives would actually be in perp form rather than rolled quarterly? Can we be objective about this? Obviously retail loves the leverage factor and the limited KYC and some of these perps, but what if it was that way? Would we be better off or worse off than we are today with a quarterly roll in the e-minis and the like?
Reid Noch:
I think for a lot of products like equities that don't have expiry dates or you don't ever really want to just have 600 bales of oil show up to your office or pork bellies or whatever, they are very useful for that. I will say they are very similar, though, to swaps. And so a lot of the debate is their classification, whether that they should be treated as futures or swaps. I know the CME is suing CFTC on that right now, and that has huge implications on retail access, how much leverage they can have as well with margin requirements, and as well as how they're treated for tax purposes. And so I think the tax, actually, angle is probably the largest implication for institutional adoption.
Peter Haynes:
And it has to do with short-term versus long-term capital gains or taxes?
Reid Noch:
Most swaps are taxed only as short-term versus most futures or a lot of futures have, I think what they call a 1256 treatment. No matter the duration, 60% will be taxes long-term, 40% will be taxes short-term. And so that could be massive even for just normal ETF trading if, Zak, if you guys are ever trading for a position that you think you'll hold less than a year.
Zak Goodwin:
Yeah, that is interesting. I know, Reid, we talked about the swap side of it for a bit, and I guess that should at least keep perps out of the hands of retail a bit or at least make it much more difficult. It won't be as ubiquitous on some of the platforms that they target and things of that nature. Is that kind of your take on it? And then I guess a second question is, are the same people that are trading overnight, that are trading triple levered inverse ETFs, are these all the same people that are trading perps? Are these people who just aren't running out of ammo here?
Reid Noch:
So the first part, I think perps are so successful, especially overseas for three aspects. One has been the 24/7 seven angle. So in the Iran conflict, we saw a huge PERP volume in oil just because Iran conflict started on a Saturday. Every domestic market's closed, hyperliquid, overseas crypto platforms, only one online. Then it's the KYC and AML arbitrage. So for a lot of these platforms, all you need is an email and a password. If you're in the US or Canada, email, password, and a VPN to do it. So you had a lot of Chinese investors, for instance, reportedly coming in using these platforms to get access to SpaceX near the IPO as they were barred from it originally. And it's the leverage angle. It's hard to find as much leverage. So if you start tackling each one of those areas, I think they become less appealing to retail.
And it's 100% right now, mostly still retail, whoever used the triple leverage ETFs in different areas there. Penny stocks also trading these aspects and a lot of market makers and hedge funds taking the other side. But you're continuing to see more institutional interest as it progresses.
Peter Haynes:
A programming note here, TD Securities does not endorse the use of VPNs to access marketplaces outside of our jurisdiction. But I think, Reid, your point is how easy it is for people in North America to access marketplaces that are outside the jurisdiction. That is a bit scary and it is a bit of a leakage and something I'm sure regulators are thinking about. So Zak, one of the things that Reid talked about for accessing leverage and gaining leverage is what is known as prediction markets. They're becoming more mainstream. People are using them as indicators. And I was looking at some of the election-related prediction markets earlier today based on some of the races yesterday for the Senate. I'm curious, how is CPP utilizing information that relates to prediction markets? And are you seeing innovations in algo logic that's incorporating information from the prediction markets?
Zak Goodwin:
To be honest, I shopped this one around the fund a little because I was curious because I haven't really heard much from it. And the takeaway, to be completely honest, is I don't have a ton to report back. In an actual investment thesis, we are not using prediction markets that frequently, as much as we love to look at them and talk about them and laugh and all of that. It's not something that has been highly built into our investment process at the moment. And I actually haven't talked to many brokers, at least from what we're using, that have these kind of prediction markets built into an algo framework.
But I would say what I do think is super interesting is the way some hedge funds or CRBs or things of that nature are using prediction markets, whether it be market implied expectations, which I think is that's a super ubiquitous one that we're looking at now, it just might not be in our investment process or cross-market relative value, macro sentiment indicators, obviously event hedging, just all things like that that I 100% think there is a place for, but I can't say that it's something that we're actively doing at the moment.
Peter Haynes:
So Reid, for perps and prediction markets, can you give us the regulatory landscape in the United States on where the regulators stand on both those products?
Reid Noch:
So right now, the CFTC has green lit perps for digital assets in the US. They also allowed for exemptive relief for Coinbase to offer their Bermuda perps to US retail on much more products, including commodities and their own equity ETFs. The CFTC, it looks like they're probably the next move would be for precious metals and working metals like copper. There's still larger debate for oil. The SEC and CFTC said they intend to work together on a regulatory framework for single stocks and ETFs. I'd still say the more immediate question though, is the CME pushing back with their lawsuit and whether they're regulated as swaps or futures. With prediction markets, I think that we're headed to the Supreme Court sooner rather than later. I feel like every other week there's some state that is fighting with the CFTC as whether it should be treated as sports betting or as swaps.
Given that over 80, 90% of the volume is sports related in the US. I think there's a strong case to be made that a lot of it is sports betting. Even if you look at the financial aspect of it, most of the financial contracts are based on prices within the next 15 minutes. And there's a bigger push to get that for commodities and stocks as well, single stocked potentially. And so it'll be interesting to see if that does go through and it is allowed.
Peter Haynes:
I read about some of the exchanges, futures exchanges considering launching sports futures contracts, and the users that they're talking about would be sports ownership franchises hedging against the number of fans that show up to games and things like that. It just seemed a bit of a stretch that the traditional market structure we're used to for futures would move into the realm of sports-oriented contracts. Is that just the reality we're living in now?
Reid Noch:
Unfortunately, I do think there's a potential regression. You can make an argument on almost any entertainment or sports-related event that there's someone that probably has taken on risk and could do something to hedge it. Though if you look at, I think, generally public good, how much of it will actually be sports owners and franchisees and bar owners or anyone who has a sports promotion versus how much of it is just everyday people trying to see which their home team will win or not.
Peter Haynes:
I guess you could say, Reid, that looking at Korea, for instance, the regulators there are trying to reduce the leverage factor in single stock ETFs in their market, when the reality is that's putting a finger on the sieve when there's so many other ways to get leverage in those same securities. I guess the same thing could be said about sports betting. If you put it on an exchange or sports-oriented activities on exchange, it's in a regulated environment and perhaps maybe it's a better place for that activity to be taking place than some of the other alternatives.
Reid Noch:
The argument, especially your sports, is the addiction aspect of it. And so the Supreme Court has generally rule that states have the right to how they protect or monitor from sports addiction or betting. And so a lot of states require that you have to be over 21, that you have to have a helpline available, that X amount of funding has to go to sort of preventive or recovery means. And then you have some states like California, which is massive, where prediction markets are most popular because sports betting is banned altogether because they see it as harmful for the public good. There's definitely arguments that a lot of the gamification of financial markets, if that's now happening too with these leverage ETFs or these leveraged products. But at least with sports, that has been historically the debate. And so there might be better regulations on a fair market with the CFTC and SEC or with different products or with sports, but they have no way to address the addiction component and for public good.
Peter Haynes:
Wow, I didn't think we'd veer into that much detail on non-equity market related stuff. So Zak, a little birdie with a big nose once told me he was very impressed by your knowledge and acumen in the electronic trading space. And I think we all know on this call who we're talking about that little birdie to be. How involved are you in understanding the emerging tools and venues that exist in the US to help reduce adverse selection and improve execution outcomes? And is it important in your mind to know how the algo sausage is built or to simply rely on the relative performance of the tools to determine which ones you should use?
Zak Goodwin:
First off, I'll say I'm shocked that that little birdie had any nice words to say about me publicly. I must have really hurt him to say that out loud, but I'll take it as a compliment. I mean, personally, I have a genuine and somewhat nerdy interest in the weeds of how these algos, routing logics, innovation at ATS is, how all this works. And luckily it all comes with the gig, so it works out pretty well. But I would a hundred percent say that we're really interested on how the sausage is made. If someone comes to us and says, "We rebuilt our store or we have new algo logic for this, or you're going to interact with our CRB here," just putting a couple numbers or plant-wide numbers in front of us generally isn't going to be enough for us to be like, "Oh yeah, go ahead, turn us on."
Those plant numbers, they're going to find a way for them to look good. So what we really try to do is get into the weeds of where are you routing? Why are you routing there? What do your toxicity studies look like? Are you embracing change with new innovation? Whether it be things like atomic pairs, expressive bidding, different private rooms now with the proliferation of them, if it's crumbling quote logic, all those things. We want to talk through with these algo teams and just know why it's additive and why they are actually making these enhancements before we're actually signed up for anything. So I think that is really the biggest part of it. And I would say also it's just being willing to change.
I always had for the longest time, if anyone was like, "Oh, we're going to use SDPs in our algos." It's like, "No, turn us off. We don't want to be involved. Keep us out of it."
Now it's like with some of the different venues and how smart people have gone about using SDPs in the right situations, it's like, okay, this can actually be additive for us in the right situation. So it's really just spending time and digging in on what's happening. And like you said, how that sausage is made for us to get comfortable, then to ultimately make a change for our best execution standards.
Peter Haynes:
Just to be clear for everyone listening here, we are referring to Chris Finora who spent some time working at CPP for over a year with Zak. And Zak had to turn his computer on for him every day, but we wish Chris the best in his future endeavors. He spent quite a bit of time sitting beside me, and so we share a lot of laughs and he did say some nice things about you. So Zak, as a follow-on question, I want to get into when you know you have enough data to eliminate noise when you're comparing performance. And I'm curious, we're in an AI-driven market right now, or at least the stocks that are driving the market are typically AI names. How is AI fitting into your workflow on your desk and in the various broker algos that you're utilizing?
Zak Goodwin:
Yeah, I'll start off with the data question. I would say that it's a tough one because what we do on the desk is we do quarterly broker reviews with different algo teams and we take our own data and then they bring us their data and we compare apples to apples and it doesn't always line up to start with. So we generally want to see multiple quarters of their own data, and then we might turn something on and have an idea of where we should come in and go from there. Obviously, market conditions don't always allow for that. And also we're not going to, if we have a quarter where we're looking at a VWOP wheel and their percentage of spread ticks up materially, it could be an anomaly with the type of flow that they're getting, how our wheel sliced it out to them, things of that nature.
So we try to smooth these things out, remove outliers and look into making these decisions over longer periods of time, but there's really not an answer of like, "Oh, we need X amount of data, and then it's statistically significant and we can move forward. "So it's a little bit of an art and a little bit of a science from that perspective.
And then from the AI side of things, I think a lot of people, AI is a buzzword, and a lot of people just have this idea that, "Oh, we're using AI for this, we're using AI for that," where a lot of things might be more like clustering or machine learning where we're looking through all brokers' performance and coming up with who's performed the best and being able to build that into an algo logic or things of that nature. And then from a broker standpoint, we get a lot of incomings on new algos for predictive AI and things like that.
We're generally cautious about them. We haven't seen a ton where we're seeing major performance enhancements. And I think it is occasionally a struggle to talk through why the AI is actually making that decision at any said point in time, which makes it hard on us. So I would say the innovation is definitely there and we just try to tread lightly and really understand the why we might be routing somewhere or doing something and not that AI is just making that decision for us.
Peter Haynes:
Yeah, you mentioned innovations, you mentioned expressive bidding, the tool from OneChronos, and it leads me to a question for Reid on some of the key developments that you're seeing right now on the horizon in terms of new ATSs, new order types, the kinds of things that Zak and his peer group need to know about. And what do you think about the notion, Reid, that we're hearing a little bit more about that US regulators might allow exchanges and ATSs to have closer relationships going forward or even ownership overlap?
Reid Noch:
So I think especially with OPR going away, you'll definitely see much more convergence between exchange and ATS functionality. I think it'll be very similar to the early 2000s where you saw exchanges gobble up ECNs and incorporate a lot of that into it. I think exchanges are really pushing for segmentation or some more novel order types, especially in their non-displayed liquidity. And so I think that's where you'll see it. They're trying to potentially leave the quote as is, more arguing again on some of those finer details we talked about earlier. So I think what we're seeing a push today right now outside of ATS moving from core hours is that we're seeing a new level of customization we haven't seen before, whether it be segmenting a pool to one specific counterparty or introducing a new novel signal within the ATS to trade. A lot of these venues rolling out this new format, OneChronos, Level, INCR and their new trajectory order book, all on a more positive side.
But there's some real concerns that you have so much custom functionality, you don't know what's entirely available and how it's being used.
Peter Haynes:
So as a follow-on, Reid, there's a new stock exchange that just completed its rollout and is now trading all symbols in the US. That's the Texas Stock Exchange. What impact do you see from this new competitor on the incumbents and other exchanges? And what do you make of the TMX Canada's leading exchange taking a 59% stake in MEMX and combining it with the box option exchange?
Reid Noch:
So I think as you and I discussed before, Texas is a very credible competitor to NYSE and NASDAQ for listings. On that side though, with some conversations, they plan on rolling out some interesting functionality to compete with ATS Flow as well as a more novel closing metric. So I appreciate they're trying to compete and innovate on the trading side too, not just on the listing side. I think we have seen that in the past where it just flattens out, but there's nothing really there and it's just more of a headache for traders.
As for the TMX, MEMX, box area, I think it's a great move by TMX. MEMX is focused more on options and being a technology provider. So it gives them an extra footing in the US and into a much more lucrative asset class too, as the real money on the exchange side, if you're not truly just listings, is options in the US, not equities. That's because 98% of exchange fees just go into the rebate.
Peter Haynes:
And interestingly enough, the options exchanges have a little bit of risk in these new forms of leverage and high octane products that are coming on board, whether it's leveraged ETFs or perps and other single stock vehicles. So it'll be interesting to see if the options market continues to be as lucrative for exchanges going forward. Zak, as we finish up, one of the great features of working on the CPP desk, and we talked about this earlier, is your ability to get exposure to market structure in every country. You referred to yourself as a nerd in market structure. So you probably have been soaking up speaking to Canadians about how things work here. You obviously an expert on that now and elsewhere in the world. If there was one feature from another region or country's market structure that you would like to see the US market import, what would that be?
Zak Goodwin:
I mean, just to back up a bit, we trade all of North America and APAC out of Toronto, and then we have a London desk that trades EMEA. And learning about all these different markets and market structure has been super interesting, even though I do question it all sometimes when the phone rings at 11, 12 o'clock about an issue in Asia. I guess I'll take it in a slightly different direction. I'm not going to pick a favorite, but I will say growing up in the ETF kind of index business, I love me a closing auction, and I can't sit here and act like I'm an expert, but I was recently looking at and just talking to someone about the new closing auction in India that just went live. And I thought that was obviously a fantastic development. And moving from that 30-minute VWOP to calculate the close to a dedicated closing auction session, that kind of stuff tickles my fancy just because from a buy-side perspective, it's a super positive change.
You're concentrating liquidity at a single auction. It should help price discovery. You have a better closing benchmark. And just that VWOP into the bell was pretty scary as someone that just started trading it. So that I would say has been a super interesting one for me.
Peter Haynes:
Yeah, that has put Mexico on a clock as the only significant marketplace in the world that doesn't have a closing auction mechanism working like a single auction that India has just introduced. And I know they're having some issues and debates down in Mexico about whether to move ahead with an original proposal or try and fast track a different proposal, but the clock is on now that India has moved forward in starting to scale into their new market enclosed facility. Congratulations to everyone that was involved in that process. We had a few of your colleagues on, former colleague from BlackRock, Winnie Qatar, and Kash Certion a few months ago talking about APAC mock, and that was a front and center issue for everyone in the APAC region to get that mock up and running. And congratulations.
When we think about things on the flip side, Zak, I'm curious if you think about some of these innovations that have started in the US market, you always wonder, are they capable of being ported to other smaller markets or do they only work because they're in the United States?
And I'm thinking about things like trajectory crossing, periodic auctions, et cetera. Are you of the view that some of these innovations in the US can in fact be successfully ported to Canada and elsewhere? Or do they work simply because of the size of the US market?
Zak Goodwin:
That's a big question. And I think speaking of Mr. Fenora, I had a lot of very friendly arguments with him on the desk just talking about US versus CAD auctions, darks, all these different things and how they work and which ones created better outcomes. I would say, and I can't act like I'm a Canadian market structure expert yet, but I will say one of the things that's most interesting to me is just the periodic auction developments coming to Canada. I think that'll be very additive instead of forcing participants to compete continuously for Q position, which is a very real thing in Canada. You're creating short windows where liquidity can accumulate and you can interact at a single clearing price. So I think that should be very, very additive for Canadian market structure. I don't know if you feel the same. Would be interesting to hear your thoughts.
Peter Haynes:
Yeah, so we have the new six marketplace launching in a month or so using intelligent crosses matching logic, which I'm sure Zak, you hear a lot from your US brokers and follow closely the success that that venue has had. We've been doing some work at TD on quoting that's taking place in the market. And what we're noticing is a enormous uptick in the percentage of the MBBO that's quoted on marketplaces that are not protected under our Canadian rules. Either have a periodic auction or an asymmetric speed bump or another feature, maybe they're less than 2.5% market share. And when I see huge quoting and smaller market share, it leads me to conclude that the tools are being used to protect quotes rather than to create a market structure that is helpful for the market. So I have a little bit of concern that maybe in some of the analysis that we've done, we need to be thinking about the accessibility of those quotes and whether or not that's additive to the overall market.
So we're in the midst of doing some research on that, Zak, so stay tuned. But I'm hopeful that these innovations will be grasped by Canadian institutions and be added to the market. So just as we finish up here for both of you, a final question. We've talked in the last 45 minutes or so about the changing landscape of equity market structure, and I would argue things are happening faster today than at any point in my personal career. If you guys had to hazard a guess, what will trading equities by institutions look like in five years? Reid, I'm going to ask you to go first.
Reid Noch:
Assuming we aren't on Mars, trading with an AI agent on blockchain, I think there is a different environment. I think 24/7 might be bigger than initially when it goes live. I think the market will be very reactive to any major news despite time of day or region. I do think AI agents will be helpful with that workflow. But if suddenly something happens with Samsung during US hours, game on. I also think potentially we see what we're talking about of SDPs meaningfully expand to the level we see in Europe with systematic internalizers. As for tokenization, I'm skeptical of any meaningful volume taking place for institutions on tokenized rails.
Peter Haynes:
What about you, Zak? Final word.
Zak Goodwin:
The Mars comment actually isn't a bad one, with SpaceX and everything at the moment. I don't have anything specific. I would just say if I have one prediction, it's just going to be the pace of change and it's just going to keep accelerating. A few months ago, like we talked about, everyone was talking about tokenization. Today, the conversation has already shifted to prediction markets, perps and whatever else. Five years from now, it'll be something none of us are talking about today and I really have no idea. And that's the exciting part, and that's why you guys will continue to be so popular. But I would just say overall, the objective hasn't changed and probably won't change from a buy-side perspective. We're still trying to minimize trading costs and access liquidity efficiently, but the tools and market structure around us are evolving incredibly quickly. So I think the key thing is to just stay curious, challenge the status quo, and embrace innovation as much as possible.
Peter Haynes:
I agree with you, Zak. We're not going to be able to predict what things are going to look like in five years, even 10 years. It's just going to be mind-boggling and the pace of change and complexity is not going lower. I'm just going to call out a wrap on today's podcast. I want to thank both Zak and Reid for joining the show and giving our audience a lot to think about. I hope you'll both come back sometime down the road so we can revisit some of your predictions for the future state of market structure and continue that fun debate amongst the market structure nerds. So thanks Reid and Zak for joining today.
Zak Goodwin:
Awesome. Thanks guys. It was a pleasure.