Regulation NMS

What Is Regulation NMS?

Regulation National Market System (NMS) is a set of rules passed in 2005 by the Securities and Exchange Commission (SEC) that sought to refine how all listed U.S. stocks are traded. The intention was to boost transparency, by improving the displaying of quotes and access to market data, and basically ensure that investors get the best price on their orders.

Understanding Regulation NMS

In addition to redesignating the NMS rules previously adopted under Section 11A of the Securities Exchange Act of 1934, Regulation NMS included new substantive requirements designed to modernize and strengthen the regulatory structure of U.S. equity markets. 

This regulatory ruling is comprised of the following four main components:

1. The Order Protection Rule: Aims to ensure that investors receive the best price when their order is executed by removing the ability to have orders traded through — executed at a worse price. This rule requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution of trades at prices that are inferior to protected quotations displayed by other trading centers. It also created the National Best Bid and Offer (NBBO) requirement that requires brokers to route their orders to the venues offering the best-displayed price.
2. The Access Rule: Seeks to improve access to quotations from trading centers in the NMS by requiring greater linking and lower access fees. This rule includes a mandate that each national securities exchange and national securities association adopts, maintains, and enforces written rules prohibiting their members from displaying cross automated quotations or quotations that lock.
3. The Sub-Penny Rule: Sets the minimum quotation increment of all stocks over $1.00 per share to at least $0.01. Stocks under $1.00 can see quotation increments of $0.0001.
4. Market Data Rules: Allocate revenue to self-regulatory organizations that promote and improve market data access.

Benefits of Regulation NMS

The intent of Regulation NMS has been to promote fair market pricing and quality in the overall market. According to the SEC, this mission has been a success, with Regulation NMS playing a pivotal role in cementing the reputation of U.S. equity markets as efficient, fair, and competitive.

The policies instituted under these regulations were also meant to address changes that have been underway in equity markets. They include the introduction of new technology, as well as new types of markets for trading in penny and sub-penny increments.

Criticism of Regulation NMS

There have been critiques of Regulation NMS, with a lot of discontent, in particular, directed at the Order Protection Rule's mandate that stocks must be traded on exchanges that show the best-quoted prices. One of the criticisms is that the rule gives an advantage to high-speed traders.

There is also a perception that the rule makes the market more expensive and increasingly difficult for pension funds and other institutions to execute trades promptly at the price they want.

Some people argue that better price visibility has pushed large investors to trade off-exchange, fueling the expansion of private exchanges, called dark pools.

Further updates to Regulation NMS have been recommended by its critics. Some have gone as far as suggesting the policies be replaced entirely in favor of new rules more in line with previous trading practices.