The Rise of Regulation in Trading Markets

There has been an undeniable surge in regulations within financial markets. From the U.S. Securities and Exchange Commission (SEC) to international financial authorities, efforts to establish, update and enforce rules have markedly increased. 

The costs of compliance and, notably, the costs of noncompliance are rising. The impact on trading markets is pressure from all sides being felt by market operators and participants alike. As firms assess their capacity to manage regulatory costs and change, it’s important they consider their technology systems and how equipped they are to meet ever-increasing demands. 

Regulation burden grows 

Large-scale change is becoming the new normal. And it’s not just anecdotal sentiment as the industry braces for North American T+1 settlement and potential updates to the SEC’s Regulation Systems Compliance and Integrity (Reg SCI) that would expand the rule’s scope to certain larger broker-dealers.

A recent survey of banks, broker-dealers, securities exchanges and financial market infrastructures (FMIs) by Nasdaq and the ValueExchange found that 64% of respondents cited increased regulation as their top external pressure.

Source: The ValueExchange, Financial Market Transition – Legacy, Growth and Collaboration

That oversight may only expand. A May 2023 report from Thomson Reuters found that nearly three in four organizations expect the volume of financial market regulation to grow. Of surveyed firms (including U.S., U.K. and EU broker-dealers, banks and regulators), 46% expect slightly more regulation over the next 12 months, while 26% expect significantly more.

Cost of compliance

As the scope of regulation increases, so too does the cost of noncompliance. In fiscal year 2022, money ordered from SEC actions totaled $6.4 billion, a record for the agency and significantly up from $3.9 billion in fiscal year 2021. Civil penalties constituted the largest share of this total, accounting for $4.2 billion, another record amount for the SEC. As the number and breadth of rules increase, industry experts anticipate proportional growth in enforcement actions and penalties. 

In the U.S. alone, recent proposals by the SEC cover a wide range of compliance obligations, from proposals to enhance cybersecurity and changes to Reg SCI to major market structure reforms such as amendments to best execution, order competition, trade reporting mechanisms and Reg NMS. If adopted as proposed, these rules could place a substantial operational and compliance burden on market participants, including FINRA-registered broker-dealers.    

Regulatory compliance is no small task—or cost. It demands extensive resources, from large compliance teams that understand how the new regulations should be implemented to system reporting capabilities and complicated internal processes that require continual review. It’s not surprising that many financial institutions are investing heavily to support these regulatory changes and are building compliance programs around them. However, even then, they may not fully understand the cost impact of regulations to their operations: The same Thomson Reuters report cited above found that 45% of organizations did not monitor the cost of compliance with all applicable regulations.

And it’s not just the hard costs of noncompliance that should give firms warning. There are also reputational risks that can cost organizations. End customers are placing increasing importance on working with entities that they trust and view as continuously investing in infrastructure and compliance operations. Those that do not meet these expectations for integrity may see losses related to their perceived reputational risks.

Compliance is tied to tech stack

As regulatory burdens rise, one risk is that they strain the technology and operating architecture of firms. The Nasdaq and ValueExchange survey found that nearly one-third of market participant systems were classified as legacy. This tension creates a balancing act between risk and innovation, between keeping the lights on and having the capacity to scale with modern regulatory demands. 

Legacy systems can be expensive to upgrade (management of legacy technology was the second-highest operational priority for participants in the survey), presenting yet another cost to compliance. As budgets are directed toward managing the growing regulatory demands, less is left for investing in new revenue-generating opportunities. Projects that drive real growth and transformation may get deprioritized or scrapped altogether in the face of potential regulatory risks.

The financial burdens and missed opportunities could potentially intensify, as there is general agreement among market players that future regulatory conditions will become even more stringent. This prediction could inevitably lead to increased technology costs within financial institutions that do not take action to modernize by leveraging scale, emerging technologies, new deployment models and cost efficiencies.

Finding the right market technology partner

In this state of continuous change, some leaders at broker-dealer firms are reevaluating the expense of their compliance and technology architecture in the shadow of growing regulations. The complexity of the upkeep and support of in-house systems adds an element of risk while demanding increases in resources and training. As such, we’ve observed a general trend toward larger financial institutions working with fewer technology partners to reduce complexity and drive greater operational efficiencies. Streamlining the tech stack can help unlock advantages, performance and cost-savings.

By working with trusted technology and compliance partners, these leaders can find an alternative strategy that allows their firms to concentrate on income-generating activities while effectively outsourcing technology and regulatory programs to market specialists.

As a global leader in trading technology services, Nasdaq can help navigate financial firms through a maze of new rules and regulations. Being a service provider to over 60 global markets, including SCI entities, we’re in a unique position to help firms address their regulatory burden. For example, Nasdaq Execution Platform (supported by the Operations and Compliance Network, LLC, also known as OCEAN) has developed a robust classification schema for SCI Alternative Trading System (ATS) customers. Our service enables clients to seamlessly collaborate to identify and report SCI events to regulators and mitigate the risks and costs of building and maintaining a Reg SCI compliance framework in-house. 

Find out more about Nasdaq’s offerings here and download our factsheet on how ATSs can leverage our Reg SCI support services.