From Block Lords to Blockchain: How Securities Dealers Make Markets

By Donald, David C. | Journal of Corporation Law, Fall 2018 | Go to article overview

From Block Lords to Blockchain: How Securities Dealers Make Markets


Donald, David C., Journal of Corporation Law


I. Introduction: Making Markets

A.The Likely Return to Private Networks

As trading concentrated on major securities exchanges disintegrates, trading is returning to direct (now electronic) networks between major broker-dealers. For most of the roughly 1000 years during which there is historical evidence of debt instruments or shares of stock being exchanged, trades were executed over informal networks among merchants or other debtholders,1 who met in market squares, designated city blocks, or their own offices.2 With the notable exception of The Netherlands, concentrated trading on securities exchanges became the rule only from the 19th century.3 Trading floors provided an environment that allowed exclusion of non-members and control of information, and in which real-time, multilateral communication of offers and acceptances was possible, but electronic communication permits the same, with even higher efficiency. Market structure changes made at the outset of the 21st century began a trend that currently projects a return to decentralized networks among major broker-dealers.4 This change has been advanced by the largest broker-dealers,5 and it is unlikely that their initiatives are contrary to their own interests, but serious thought has not been given to how a full return to disintegrated trading would affect the interests of savers, issuers, regulators, and other concerned constituencies. The history of markets offers insight on this.

A return of trading to private networks affects "market quality," both in a narrow and in a broad sense. Although it is not customary in the literature to distinguish between narrow and broad concepts of market quality, such a distinction can be drawn by reference to the set of affected constituencies included in an analysis. A narrow (indeed the customary) examination of market quality focuses on how the market affects the interests of direct market participants, the broker-dealers licensed to trade in the market, assessing primarily trading costs and speed. Using this measure, it would be unusual for market structure innovations not to have a positive effect on market quality, for as Francioni and Schwartz remind us, broker-dealer members of exchanges find "investors and the listed companies . . . important primarily because they are critical for the profitability of the members. Nevertheless . . . the interests of the intermediaries come first."6

B.How We Measure the Quality of Securities Markets

Securities markets are built by the broker-dealers for the broker-dealers, but are not solely of the broker-dealers. Many of the securities traded are linked to returns from activity in the real economy, and many investors based in the real economy buy interests in traded securities. Nevertheless, regulators measure the quality of a market on the basis of benefit to its owners, not in connection with the broader economy. As Lee observes, though "mounting anxiety about the presence of conflicts of interests at market infrastructure institutions, and about whether governance mechanisms should be put in place to minimize the occurrence of such conflicts" has been the subject of detailed examinations and proposals,7 little or no attention is given to the fact that broker-dealers and the institutions they own control the design of key infrastructure for national economies.8 When a regulator is guided by a narrow concept of market quality, it essentially asks: have the broker-dealers constructed a market for themselves from which they can extract maximum profits at minimum transaction cost?9 While this may well include an assumption that the savings of broker-dealers will be passed on to the real economy, nothing in applicable theory or practice supports such an assumption.10

In contrast, a broad concept of market quality places the assessed market within the overall economy and evaluates its structure and performance in connection with that economy.11 Broad market quality includes the effects of market design on investors and listed companies, regulatory budgets, and those broker-dealers who might be excluded from the market under a given structural arrangement. …

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