Innovation in the Stock Market: Exchanges and ATSs
Is something wrong with the structure of the stock market? Both industry participants and scholars have recently faulted the equity market for its lack of innovation. Economists at Harvard, Chicago, and elsewhere have argued that the continuous nature of modern trading bakes in a problematic arms race among high-frequency traders for speed. Stock exchanges process incoming instructions to trade in the order they arrive and as quickly as possible, which can mean in millionths of a second or less. The result, they argue, is a wasteful race for speed in order to trade first on public information. This race would be eliminated if continuous trading was replaced with discrete, periodic auctions (“frequent batched auctions”), say once per thousandth of a second. The market, these scholars also claim, will not fix itself because the nation’s stock exchanges lack robust incentives to appropriately innovate. (See, e.g., Budish, Lee & Shim, 2020).
In a forthcoming paper, I start off with the fact that there are other important markets for trading stock besides the national stock exchanges. I argue that the innovation calculus for alternative trading systems (“ATSs”) differs markedly from exchanges. ATSs, like stock exchanges, are marketplaces in which traders interact to purchase and sell stock from one another. In fact, ATSs and exchanges often function very similarly, with the same trading mechanics, technology, and participants, and both satisfy the statutory definition of a stock exchange. The defining difference between them is that exchanges choose to register as self-regulatory organizations, with closer supervision by the Securities and Exchange Commission (“SEC”), while ATSs make use of an exemption from registration as exchanges to operate in a less regulated environment.