The ABCs of Equity Market Structure

How US Equity Markets Work and Why

Key Takeaways

Key to delivering efficient, reliable, and low-cost markets is the underlying market structure. Before we can deep dive into the data, we must set the foundation to analyze market structure. This note does just that, explaining terminology, market participants, and the structure of markets:

“The” retail investor is not monolithic: 53% of U.S. households own equities. Individual investors in the $100K-$1M tier represent 33M HH & hold $6.5T in assets; 78% use financial advisors, average relationship size $135K. Technically there is no definition of retail investor in equity market structure
Firm business models are not monolithic: Different business models serve different customers with different investment objectives/trading requirements. 35K firms (90.3% inv advisors, 8.3% BDs, 1.4% dual), 690K registered reps. Labeling firms can be complicated – firms may hold multiple labels (market maker, broker-dealer, etc.)
Equities not equal to listed options: equities ~8.3K securities, options ~1.5M strikes. 16 exchanges each; differences exist. Equities order driven, options quote driven. Auctions exist in equities but expanding to retail orders brings up questions, such as how to design and what if no take up
Cash flows across the trading ecosystem: Net trading revenue 62.1% of reported revenue for order routing/execution firms. Equities 9.1% of total net revenue for exchanges, transaction revenues 60.0%. Exchanges’ cost of revenues 82.1% of total equities revenues, order routing/execution firms’ transaction expenses 47.0% of total operating expenses. SIP market data revenue $414.4M (5Y avg). PFOF/net price improvement = 0.3x – price improvement much greater. Section 31 fees $376.5M on avg per exchange (FY22), may be passed on to investors

Executive Summary

Introduction to Equity Market Structure

The U.S. equity market structure ecosystem is complex, with many moving pieces all intertwined to deliver the largest – 41.0% of the $101.1 trillion global equity market cap, or $41.5 trillion; 3.6x the next largest market, China1 – and among the deepest, most liquid and most efficient markets in the world.

Key to delivering efficient, reliable, and low-cost markets is the underlying market structure. Market structure can drive liquidity and trade costs. Therefore, market participants continually strive to create the most efficient markets. This includes adapting new technologies to achieve operational efficiencies, searching for new ways to transact and, generally, sculpting market structure to maximize efficiencies.

Over the last year, much attention was paid by regulators as to whether or not the current equity market structure creates “well-functioning markets that are efficient, competitive, and transparent”. And in December last year, the SEC released its (much anticipated) statement on proposals related to equity market structure. The proposals include: amendments to disclosure of order execution information (Rule 605); changes to tick sizes, access fees, odd lots and round lots; introduction of an order competition rule, aka the auction proposal; and a new SEC version of Regulation Best Execution.

We believe the current ecosystem does serve investors to the fullest. The retail investor has never had it better on trade costs ($0 commissions) and the ability to execute trades in a quick and cost-effective manner. Institutional investors have many opportunities to access liquidity. That said, we would agree that reviewing regulations and processes in markets over time is a reasonable action. After all, Regulation National Market System (NMS) came into effect in 2005. However, we caution that equity market structure has a lot of tentacles. Opening one aspect could have unintended consequences, such as negatively impacting retail investor participation.

The intent of this report is to break down the complexity of and analyze data for U.S. equity market structure. Before we can deep dive into the data, we must set the foundation to analyze market structure. This note does just that, explaining terminology, market participants, and the structure of markets.

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