What Is Regulation NMS?

Regulation National Market System (Reg NMS) is a set of rules passed in 2005 by the Securities and Exchange Commission (SEC), which looked to improve U.S. securities exchanges through improved fairness in price execution as well as improve the displaying of quotes and amount and access to market data.

Key Takeaways

  • In 2005, the SEC issued the Regulation National Market System (Reg NMS) to strengthen U.S. securities exchanges and account for changing technology.
  • The goal of Reg NMS was to improve market efficiency and fairness.
  • The regulation included four new rules related to order protection, improving access to market data, and decimalization of price quotes.

Understanding Regulation NMS

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

This regulatory ruling is comprised of four main components, which are:

  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. This rule 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 aims to improve access to quotations from trading centers in the National Market System (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.

The intent of Regulation NMS has been to promote fair market pricing and quality in the overall market. According to the SEC, Regulation NMS has been a key factor in the equity markets in the U.S. being recognized for its efficiency, fairness, and competitive nature.

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

Critiques of Regulation NMS

There have been critiques of Regulation NMS, in particular, the Order Protection Rule that mandates 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. Pension funds and other institutions can also find it more difficult to execute trades. 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 current trading practices.

Understanding the National Market System (NMS)

The National Market System was created by the Securities Acts Amendments of 1975 and is overseen by the National Association of Securities Dealers (NASD) and NASDAQ, now under the name FINRA. The NMS governs exchange-based trading, such as on the New York Stock Exchange and OTC trading on the NASDAQ. For practical purposes, the NASDAQ is considered an exchange, even though the negotiations occur directly among market markers.

To facilitate the fair distribution of information, the NMS requires that exchanges make bids and offers (ask price) available and visible to both retail and institutional investors. The advantages are an increase in liquidity and better prices. However, the system makes it difficult for institutions and large investors to execute large trades unnoticed. Some people argue that this visibility has pushed such trading off-exchange, fueling the expansion of private exchanges, called dark pools.