In Drift Into Failure, a book that I believe all regulators, and indeed anybody attempting to understand and make recommendations about complex industries must read, Sidney Dekker explains how regulators can adapt to the understanding that regulating a complex system is nearly impossible:
“If a regulator cannot regulate a complex system, then what can it do? Will a regulator always be caught behind the curves of self-organization and emergence, holding a bag of obsolete rules that came from less evolved systems? … Rather than a regulator, complex systems should have a co-evolver/counter-evolver. This must be an organization that has the requisite variety not only to have an idea of the complexity of the operational organization (and thus has to co-evolve with how that organization evolves). It should also have requisite variety to counter-evolve.”
He goes on to make many recommendations around safety inspection and oversight, and enhancing the creativity and diversity of the operations being regulated. The Healthy Markets Initiative’s platform is structured to do exactly these things - make subtle changes on the edges, enhance oversight and measurement capabilities, and measure the impact of ideas that would increase the diversity of participants and timescales for market makers on lit markets.
However, it does not delve into the structural changes that regulators can make, even within the difficult, unwieldy bureaucracy they are forced to work through. When it comes down to it, the attitude of regulators towards data, research, openness of process, and transparency has not changed in decades. For example, recently FINRA proposed to expose dark pool volume data in the most limited way possible for free, and to charge exorbitant amounts for reasonable, machine-readable access to that data. In this case, the regulator is actually trying to profit. KOR has filed a comment letter with arguments as to why this data, along with most other data in the hands of regulators, should be made freely and openly accessible in machine-readable formats.
If regulators have any hope of contending with the complex reality they are confronted with in their attempts to reform the financial services industry and equity markets specifically, they need to re-align their approach with the 21st century. President Obama recognized this last year with his Executive Order that government should default to providing data for free, in machine readable formats. Data.gov has become a shining example of the impact that regulators in other areas have had by embracing open data, with 90,925 datasets produced by the US Government that are freely available.
Technology has fundamentally changed nearly every aspect of our lives, and every single industry. Financial services in particular has been transformed. Unfortunately, regulators have not maintained pace. To attempt to enumerate the ways in which regulators are behind the industry could be an entire white paper. Instead, I’d like to urge regulators to make a shift in how they approach data and the regulatory process with these values:
Transparency: "Sunlight is ... the best of disinfectants." – Supreme Court Justice Louis Brandeis.
Crowdsourcing: Leverage interest by the public and academics for great gain using innovative adaptations from other industries, such as prize-based contests.
Open Data: At all times, ask how can we provide easier, freer, better access to data?
Open Regulations: As the SEC works through new rules and regulations, open the process up. Leapfrog the comment letter and borrow ideas from open source development.
First and foremost, transparency should always be the #1 goal in any action or initiative. There should be nothing to hide anywhere. If regulators want to instill more confidence in their abilities and leverage insights of the public, everything should be open and visible.
Second, regulators should be focused on interesting ways to engage the public. The ideas behind Open Data and Open Regulations follow naturally from this. There are other ways and other ideas out there. In my 2012 US Senate Testimony I proposed a prize-based mechanism for crowdsourcing surveillance and market manipulation algorithms. With a $1,000,000 price, the SEC could reap the benefits of millions upon millions of dollars of man-hours devoted to a critically important task. Results from efforts such as Kaggle have been stunning: a better algorithm to map dark matter, better forecasts for flight delays due to weather, and innovations in better predicting health care outcomes. Other government agencies have recognized the value in this motivator, it’s time for the SEC to explore it.
Third, Open Data insists that data should be freely available at every opportunity. This includes:
FINRA’s dark pool volume reports
All ATS filings
Enhanced MIDAS (“Enhanced” means adding dark pool orders, hidden orders on lit exchanges and IOCs. Eventually it means adding futures and options too.)
For MIDAS, access can easily be provided by API, so that actual data is never visible to the researcher. The SEC could take lessons from the FDA, which has recently launched the OpenFDA project, heeding President Obama’s Executive Order. Their ideas around Next-Generation Sequencing are inspirational, and show a regulator co-evolving with technology and “big data.”
Dark pool reports and ATS filings are critical pieces of information. FINRA, a regulator, is attempting to profit by charging for dark pool volume data that should be freely available, and the entire industry should be outraged. For ATS filings, so much of the controversy around dark pools would be solved by simply making filings public.
Finally, Open Regulations. Why doesn’t every government agency contract with Wikipedia, and put everything out there for the public to see? Proposed rules and regulations could be shown, along with any and all changes that are made to them, who made them, and what the justification is behind the change. Changes can be challenged, evidence and research provided, and the resulting regulatory policy would be far better for it.
These are the fundamental changes that co-evolving entails. It means becoming more nimble, re-orienting the agency towards modern approaches with data, using modern techniques to leverage the huge number of practitioners out there who want to help improve market structure and the regulatory framework in general. While it is a longshot, if the SEC were to adopt these ideas, they would transform the nature of government regulation; our country and economy would be far better for it.