Skip to main content
diversification.com
← Back to N Definitions

Nms securities

What Are NMS Securities?

NMS securities refer to equity securities that are subject to the rules of the National Market System (NMS), particularly Regulation NMS, a comprehensive set of regulations enacted by the Securities and Exchange Commission (SEC). This regulatory framework falls under the broader category of Market Structure & Regulation, aiming to modernize and strengthen the operational structure of U.S. equity markets. The primary goal of Regulation NMS is to ensure fair and efficient trading, promoting transparency and fostering competition among market participants, ultimately benefiting investors by facilitating the best possible order execution.

History and Origin

Before the establishment of the National Market System, the U.S. securities market was highly fragmented. The same stock could trade at different prices across various venues, and crucial trade information was not consistently reported across all exchanges, making it difficult for traders to compare prices efficiently. In 1975, the Securities Acts Amendments of 1975 authorized the SEC to facilitate the establishment of a national market system for securities, addressing this fragmentation.

Building upon this foundation, the SEC issued Regulation NMS in 2005, which became fully effective in 2007. The regulation was designed to adapt the market structure to technological advancements, such as automated trading, and to address new challenges. Regulation NMS encompasses several rules focused on improving price transparency, enhancing access to market data, and ensuring that investors receive the best available prices for their NMS securities.7,6

Key Takeaways

  • Regulation NMS is a set of rules passed by the SEC in 2005 to govern the trading of U.S. listed equities, known as NMS securities.
  • Its core objectives are to foster market efficiency, enhance market transparency, and ensure fair price execution for investors.
  • Key components include the Order Protection Rule, Access Rule, Sub-Penny Rule, and Market Data Rules.
  • Regulation NMS aims to ensure that orders for NMS securities are executed at the National Best Bid and Offer (NBBO) across various trading venues.
  • The regulation has been credited with improving execution speeds and narrowing bid-ask spreads for NMS securities.5

Interpreting NMS Securities

Interpreting the trading of NMS securities primarily involves understanding how Regulation NMS influences market behavior and safeguards investors. The regulation's various rules dictate how orders are displayed, accessed, and executed across different trading venues.

The Order Protection Rule, often referred to as the "trade-through rule," is central to this interpretation. It mandates that trading centers must establish and enforce policies to prevent the execution of trades at prices inferior to "protected quotations" displayed by other trading centers. This rule effectively means that a broker-dealer receiving an order for an NMS security must seek to execute it at the NBBO, ensuring the investor gets the best available price at that moment. This rule is crucial for maintaining fairness and competition in order execution for NMS securities. The Access Rule, another component, facilitates fair and non-discriminatory access to quotations across trading centers and sets limits on access fees.4

Hypothetical Example

Imagine an investor places a market order to buy 100 shares of Company X, an NMS security. At the time the order is placed, several different exchanges and trading venues are displaying quotes for Company X.

  • Exchange A offers to sell at $50.00
  • Exchange B offers to sell at $50.01
  • Exchange C offers to sell at $49.99

Under Regulation NMS's Order Protection Rule, the investor's broker-dealer is obligated to route the order to Exchange C (or an alternative venue) to secure the $49.99 price, as this represents the best available offer (the National Best Offer). Even if the broker-dealer has a direct connection or preferred relationship with Exchange A, the rules governing NMS securities require them to prioritize the better price available elsewhere. This ensures that the investor receives the most favorable bid-ask spread for their trade.

Practical Applications

Regulation NMS has profound practical applications across the U.S. financial landscape, shaping how NMS securities are traded and regulated.

  • Exchange Operations: All U.S. stock exchanges and alternative trading systems (ATSs) must adhere to Regulation NMS rules regarding order display, execution, and data dissemination for NMS securities.
  • Broker-Dealer Compliance: Broker-dealers are required to have policies and procedures in place to ensure best execution for their clients' orders in NMS securities, often leveraging smart order routing technology to comply with the Order Protection Rule.3
  • Market Data Aggregation: The regulation has driven the development and use of consolidated market data feeds, which aggregate quotations and trade reports from all exchanges and trading centers. This provides a comprehensive view of pricing for NMS securities.
  • Regulatory Oversight: Organizations like the Financial Industry Regulatory Authority (FINRA) monitor compliance with Regulation NMS, issuing guidance and taking enforcement actions where necessary.2

Limitations and Criticisms

Despite its stated goals of improving market efficiency and fairness, Regulation NMS has faced criticisms, particularly concerning its unintended consequences.

One significant criticism centers on the rise of high-frequency trading (HFT). Some argue that the Order Protection Rule, while aiming to ensure best prices, inadvertently created incentives for HFT firms to rapidly execute trades across multiple venues, contributing to increased market complexity. Another concern is the growth of dark pools and other off-exchange trading venues. Critics suggest that the transparency requirements of Regulation NMS, by making orders visible, encourage large institutional investors to execute trades in dark pools to avoid revealing their intentions and potentially moving the market. This can lead to reduced liquidity and price discovery on lit exchanges.,1

Furthermore, some argue that the regulation has contributed to market fragmentation, making the market structure more difficult to understand for retail investors. There are ongoing debates and proposals from regulators and industry participants to re-evaluate or modify certain aspects of Regulation NMS to address these concerns. The SEC Chair has pushed for potential changes to market structure, indicating ongoing scrutiny of the regulation's impact on contemporary markets.

NMS Securities vs. National Market System (NMS)

The term "NMS securities" specifically refers to the securities (primarily listed equities) that are traded under the rules of the National Market System. In contrast, the National Market System (NMS) is the broader regulatory framework and infrastructure itself.

The National Market System (NMS) encompasses the entire operational structure of U.S. equity markets, including the exchanges, trading venues, data processors, and regulatory bodies, all designed to facilitate efficient and fair trading. Regulation NMS is a key component within the National Market System, implementing specific rules to achieve the system's objectives. Therefore, while "NMS securities" are the assets governed by these rules, the National Market System is the overarching system in which they operate.

FAQs

What types of securities are considered NMS securities?

NMS securities primarily refer to equity securities listed on national securities exchanges in the United States, such as the New York Stock Exchange (NYSE) and Nasdaq. These are typically common stocks of publicly traded companies.

Who enforces the rules governing NMS securities?

The primary enforcer of rules governing NMS securities is the Securities and Exchange Commission (SEC). Additionally, self-regulatory organizations like the Financial Industry Regulatory Authority (FINRA) and individual exchanges (like NYSE and Nasdaq) play a significant role in enforcing these rules among their members and participants.

How does Regulation NMS impact my trades as an investor?

Regulation NMS aims to ensure that your orders for NMS securities receive the best available price across all competing markets. This is primarily achieved through the Order Protection Rule, which generally prohibits "trade-throughs" (executing an order at a price inferior to a publicly displayed, accessible better price). This means your broker is obligated to seek the best order execution for you.

What is the main goal of Regulation NMS?

The main goal of Regulation NMS is to enhance the fairness, efficiency, and competitiveness of the U.S. equity markets. It seeks to achieve this by improving market transparency, promoting competition among trading venues, and ensuring that investors receive the best possible prices for their NMS securities. This contributes to overall market quality and liquidity.