By John McCrank
NEW YORK (Reuters) - A key rule governing the U.S. stock market that effectively forces stock orders to be sent to the exchange displaying the best quoted price is outdated and should be scrapped, said an executive of the world's largest sovereign wealth fund.
The "order protection rule" was put in place in 2005 as part of a broader framework known as Regulation National Market System and was aimed largely at ensuring mom-and-pop retail investors obtain the best price.
But retail orders almost never actually trade on stock exchanges. Retail brokerages now sell the bulk of their orders to other brokerage firms at prices at least as good as those seen on exchanges. Those orders are then matched internally.
Institutional investors, however, hold 80 percent of U.S. stocks and are far more active market participants, Øyvind Schanke, chief investment officer of Norges Bank Investment Management, said in an interview on Monday.
"The protected quote is not doing institutional investors any favors," said Schanke. NBIM manages The Norwegian Government Pension Fund Global's $830 billion fund.
"I would like to be the one in charge of where I am executing and the protected quote protects price, it doesn't protect size, and size is much more important to me than price."
Schanke and other critics of the order protection rule say it has created a fragmented trading environment where high-speed traders have an advantage.
A quote on an exchange for 100 shares priced a penny better than a quote for 10,000 shares on another exchange will be hit first, after which the price of the larger order on the other exchange routinely moves away nearly instantaneously.
"Arguably, the total volume is much higher now than it was 15 years ago, but still, you have to be much lighter on your feet in order avoid being picked off," Schanke said.
Algorithmic trading has become more challenging in the U.S. market over the past couple of years, he said. As a result, NBIM has focused on trading blocks of stock using off-exchange trading platforms and it does around half of its volume using telephone brokers.
NBIM has had success trading on IEX Group's alternative trading system, where orders are slowed by 350 microseconds, de-emphasizing speed in favor of larger trades, he said.
IEX has applied to become a public exchange, drawing the ire of some trading firms and incumbent exchanges that say exchanges are prohibited from slowing down orders.