Is the SEC's Market Rules Overhaul Good for Small Investors?; Texas Goes After BlackRock; Fed May be Tougher on Fintechs; FDIC Is No Crypto Friend; Digital Asset Lobbyist Loses Primary
Capitol Account: Free Weekly Version
We dug up some studies that question whether the SEC’s push to overhaul market rules will actually help small investors. Also, the Federal Reserve made a little noticed filing in a lawsuit that shows how difficult it may be for crypto banks to get access to the central bank’s master accounts. Texas went after BlackRock. The FDIC, meanwhile, is taking a tough stance against crypto. And, a digital asset lobbyist loses (by a big margin) in a New York congressional Republican primary. Some interesting stuff about her finances and donors came out in public documents.
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Market Rules: GameStop and the other meme stock insanity may have slipped from the headlines, but the SEC hasn’t lost its focus on new market structure rules. In fact, agency staff have been working away with the goal of getting out a proposal probably by late fall (though this is pretty complex stuff and the timeline could slip). Some of the big finance players with vested interests in the debate have had virtual meetings this month with commission officials.
SEC Chair Gary Gensler offered a hint of his extensive plans for the first overhaul of market rules since 2005 in an early June speech – sparking a flurry of industry questions and concerns. Among his suggestions were sending retail orders to auctions where trading firms and others could compete to handle them. He’s also flagged the practice of payment for order flow for substantial changes, if not a ban. This hasn’t sat well with the so-called wholesalers like Citadel Securities and Virtu Financial who’ve built their businesses on the current equity market model. These firms execute the vast majority of retail transactions (and routinely get the best prices, they point out). Brokers benefit as well; the payments have allowed firms to offer no commission trading.
Any time the SEC looks to make changes to market structure, there’s a big outcry from all major participants (stock exchanges, trading firms, brokers etc.). And the lobbying can take on epic proportions as everyone looks to protect their turf. Adding to the fun is that everything in today’s trading universe is interrelated. A revision in one area is likely to create a problem (or several problems) in another. Get ready for an action-packed fall.
We bring you some developments that are likely to have an impact on the debate. One is a paper from Charles Schwab that is circulating among policy makers. The second is an independent study released this month that gives some credence to the arguments that payment for order flow doesn’t have a material impact on the quality of trade execution.
White paper: Schwab, which takes payment for order flow, makes the case for keeping the current system, with a few tweaks and stepped up disclosure for investors. The firm also crunched some numbers to show the financial benefits its customers reap from getting their trades routed to market makers.
Perhaps more important than the actual arguments, however, is that the study signals that the well-known retail broker is stepping up its Washington advocacy in the market structure area. That would give a big boost to the other opponents of Gensler’s reforms – and take some heat off of firms like Citadel Securities and Robinhood whose public images have been dented by the GameStop episode and the ensuing political blowback. Many other brokerages are also wary of the planned changes the SEC has outlined. But they have largely kept their heads down thus far.
Here are a few details and quotes from the Schwab paper:
If it ain’t broke…: “Today’s transparent, competitive U.S. equity markets are the deepest, most liquid, and most efficient in the world, which allows investors to enjoy narrow spreads, low transaction costs, and fast execution speeds. These market characteristics are championed by the SEC and its longstanding goal of enhancing and protecting the retail investor experience. While there remain opportunities to improve this market even further, we are concerned that some calls for reform are obscuring the benefits of the current ecosystem to retail investors, which include vastly expanded product offerings, world‐class trading platforms that rival those used by investment professionals, no/low‐cost trading, and superior execution quality. To the latter point, we estimate that over the next 10 years, the current market structure will provide over $120 [billion-plus] of direct benefit exclusively to retail investors – we do not want to put this at risk.”
Some statistics: “Utilizing non‐exchange market centers, in 2021, Schwab’s clients received $2.7 [billion] in gross price improvement on equity orders … These are real dollars in the pockets of retail investors … Using publicly available exchange data, we estimate that routing to wholesalers saved Schwab’s clients at least $3.4 [billion] in 2021 vs. what their outcomes would have been from utilizing exchanges.”
Don’t hurt the little guy: “If marketable flow were routed directly to exchanges instead of our current routing strategy, retail investors would be disadvantaged as they would receive worse execution quality and would pay higher transaction costs. If regulation or legislation were to restrict the ability of off‐exchange venues to compete for executions, the trading costs for our retail investor clients would rise, effectively creating a transfer of wealth from the retail investors that we serve to other market participants.”
Potential reforms: Schwab charges wholesalers the same flat rate for the order flow, and it directs the business to the firms that provide the best price on the trades. The broker suggested a similar model be applied to the industry, saying it could tamp down conflicts. “Schwab would be supportive of regulations that aim to set a cap on order routing revenue rates. This would fulfill the SEC’s objective of protecting retail investors by ensuring PFOF rates do not become excessive, potentially to the detriment of execution quality.”
Independent Study: Also making the rounds is a recent academic research paper that concludes payment for order flow doesn’t lead to retail traders getting worse prices on stock trades. In fact, of the brokerages included in the study, the firm that received the most payments last year – TD Ameritrade – also got its customers the most price improvement on their transactions.
The findings, published Aug. 13, are being talked up by Wall Street executives – as evidence that payment for order flow isn’t the boogeyman that Gensler and other critics have made it out to be. They also say it shows that the current market dynamics are working quite well for smaller investors…. (Thursday)
Master Accounts: The Fed’s announcement last week that it had set a formal process for granting fintech firms access to its coveted payment system was met with cautious optimism by the crypto industry – firms saw the move as a pathway to secure a valuable credential that will let them better compete with banks. Far less noticed, however, was a legal brief one of the Fed’s reserve banks filed one day later that takes great pains to lay out the challenges the central banks face in approving the applications. Some regulatory officials who’ve read the document say one important takeaway is that it shows the fintech’s positive outlook may be misguided.
The filing was submitted Aug. 16 by the Kansas City Fed in response to a June lawsuit brought by Custodia Bank. The Wyoming-based crypto firm claims it’s been harmed because the Fed and Kansas City Fed have been sitting on its master-account application for almost two years. The litigation is being closely watched by Wall Street, regulators and lawmakers because of its sweeping implications for the U.S. financial system.
If Custodia prevails, it could set a precedent that significantly boosts the business prospects of some online upstarts. Getting a Fed account would allow them to quickly send money around the globe without paying hefty fees to intermediary banks. But critics (which include a lot of their competitors) are worried that if digital-token companies get master accounts, they would be able to start parking their assets on the Fed’s balance sheet and could potentially tap its funding spigots. That could open the central bank up to major new risks…. (Wednesday)
Woke Wall Street: There’s no summer slowdown in the ESG political wars. And, little surprise, BlackRock remains the biggest target. The New York asset manager headed a list of ten financial firms that the Texas comptroller today identified as “boycotting energy companies.” The label is a step that could eventually lead to some state pension funds selling their shares and pulling their business from the singled-out companies.
The rest of the firms cited by Glenn Hegar, the comptroller, were European, including major banks UBS, Credit Suisse and BNP Paribas. Hegar also named almost 350 funds that could be subject to similar treatment. They include offerings from other well-known money managers like Fidelity, Goldman Sachs, State Street, Invesco, Janus Henderson, JPMorgan, Nuveen, Pimco, TIAA and Vanguard. A link to the entire list is here.
Though this is just a state matter, Hegar’s statement didn’t shy away from the broader political fight that has erupted over ESG:
“The environmental, social and corporate governance (ESG) movement has produced an opaque and perverse system in which some financial companies no longer make decisions in the best interest of their shareholders or their clients, but instead use their financial clout to push a social and political agenda shrouded in secrecy … This research uncovered a systemic lack of transparency that should concern every American regardless of political persuasion, especially the use of doublespeak by some financial institutions as they engage in anti-oil and gas rhetoric publicly yet present a much different story behind closed doors.”
Background: Today’s move comes after Texas passed a law last year that seeks to cut ties with financial firms that won’t do business with oil and gas companies. It has two provisions: one that requires contractors with any government entity to certify they don’t boycott energy companies, and another that prohibits state pension funds from owning the publicly traded securities of firms on the comptroller’s list. (That ban could apply to actual BlackRock or UBS shares, for example, but also some of their funds.)
Other firms called out today: Danske Bank, Jupiter Fund Management, Nordea Bank, Schroders, Svenska Handelsbanken and Swedbank. (Wednesday)
Another Agency Is Down on Crypto: The FDIC got lots of attention last week for demanding that five companies – including major token trading platform FTX – stop making misleading statements that assets parked at crypto exchanges are backstopped by the federal government. The orders, agency insiders say, can also be seen as an indication that the bank regulator is stepping up its game on digital assets. There is more to come, they add, both on the policy and enforcement side.
While the FDIC is often thought of as a sleepy bank overseer with limited authority, Acting Director Martin Gruenberg is intent on positioning the agency as an aggressive watchdog of crypto, sources say. Since taking over in February, he’s made it clear behind the scenes that he’s no fan.
“He thinks crypto is silly,” says one person who’s familiar with the FDIC chief’s views. “He is very skeptical that there’s any value in this stuff. He thinks it harms consumers and harms banks.” An agency spokesman declines to comment.
To those watching closely, there have been a few signs of Gruenberg’s approach. But few have pulled all the threads together. Earlier this year, for example, the FDIC stopped participating in some inter-agency policy work it had been doing with the Fed and the Office of the Comptroller of the Currency on crypto. That included an effort to issue regulatory guidance for banks that custody clients’ tokens. One internal theory for why the FDIC pulled back, the people say, is that Gruenberg didn’t want to leave the impression that the agency was supportive of lenders handling virtual currencies.
In April, the FDIC publicly urged its banks to engage with their supervisor before getting involved with the asset class. Firms already doing business in the area were told to “promptly notify” the agency. The FDIC said it was issuing the so-called financial institution letter because it believed it was difficult for both lenders and the regulator to “adequately assess the safety and soundness, financial stability and consumer implications” of crypto.
The watchdog was further jolted into action by the July bankruptcy of Voyager Digital – a crypto lender that had given the impression that some of its accounts were covered by FDIC deposit insurance. Almost immediately, the regulator initiated a broad review to determine if other firms might be making similar disclosures and putting customers at risk, say the people familiar with the matter. The FDIC, the people point out, took this aggressive step partly because officials were concerned the agency could have egg on its face if more virtual-currency companies collapse. (Tuesday)
Bond Loses: Perhaps crypto money can’t buy everything. Trade association executive Michelle Bond turned to her industry connections to raise more than a million dollars – more than double her next closest opponent Nick LaLota – for her New York congressional campaign. But she ended up with a little more than half his votes. LaLota garnered 47.4 percent in the Republican primary, while Bond had 27 percent, according to the unofficial New York State Board of Elections tally. A third candidate, Anthony Figliola, was close behind with 25.2 percent.
Still, some interesting details emerged during the race. Here are a few:
Money: FEC filings show Bond, the CEO of the Association for Digital Asset Markets, raised some $1.1 million, more than double LaLota. The tally also includes $145,000 that Bond donated herself and $655,000 she loaned the campaign. Bond has also been heavily backed by the Crypto Innovation super PAC, which threw $1.3 million into the effort, according to OpenSecrets. (Bond’s significant other is Ryan Salame, the co-CEO of FTX and a major Republican donor.)
Well-known contributors: A bevy of D.C. lobbyists and others in the crypto universe have cut Bond checks. They include: Skybridge Capital’s Anthony Scaramucci; Alex Sternhell, a former Democratic Senate Banking Committee aide who’s now a leading crypto advocate; Andrew Olmem, a past Trump NEC deputy director now with Mayer Brown; Ryne Miller of FTX (ex-CFTC aide), Former Representative Mike Conaway, whose lobbying clients include Bond’s trade association and FTX; Ken Spain of Narrative Strategies, and Dan Gallagher and Conor Carney, both of of Robinhood.
Former Republican SEC Commissioner Paul Atkins was out last week soliciting donations for the campaign, saying in an email that “I can promise you that Michelle will work hard for sound cryptocurrency policy in the halls of Congress.” He also noted that while there was no time to hold a standard fund-raiser, “once she wins, your donation will provide you with the opportunity to meet Michelle at an intimate gathering that I plan to host after the primary election.”
High-profile backers: Donald Trump Jr.’s support has allowed Bond to say she is the “only MAGA endorsed candidate” in the race. Bond is also backed by Kim Guilfoyle and Senator Ted Cruz.
Finances: Bond’s financial disclosure, filed on Aug. 1, shows that she’s been paid $250,000 so far this year by ADAM. In 2021, she earned $300,000. In addition, Bond does consulting work for FTX (where, as we noted above, her boyfriend is the co-CEO). She’s pulled in $200,000 from the company this year, and another $200,000 in 2021. Bond also reported more than $21,000 in income from the blockchain financial services firm Securrency.
Investments: The public form also broadly lists Bond’s investments. And yes, she does practice what she preaches. She disclosed owning between $100,000 and $250,000 in Bitcoin (values are reported in ranges) and less than $1,000 worth of Ethereum. Bond also said she had invested between $50,000 and $100,000 in two crypto venture capital funds.
Lastly: Bond’s career includes a stint on the business side of Bloomberg, overlapping for a time with Capitol Account’s two authors.
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