What it means
In the US, a share can be traded on many venues, including several exchanges, alternative trading systems and the trading desks of large brokers. Without rules, a buyer could end up paying more on one venue when a lower price was available on another.
The National Market System idea, which goes back to the 1970s, is that these venues should work as one connected market. Regulation NMS put this idea into detailed practice.
Its best-known part is the order protection rule, which aims to stop a trade from happening at a worse price on one venue when a better, quickly accessible price is displayed on another. This is called a trade-through, and the rule requires venues and brokers to have systems to avoid it.
Other parts of the regulation deal with access, minimum price steps and data. The access rule limits the fees venues can charge for using their quotes and requires fair access to them.
The sub-penny rule generally prevents quoting prices in fractions of a cent for stocks priced at $1 or more, and the market data rules govern how information on quotes and trades is collected and shared. The result is the national best bid and offer, or NBBO, which is the highest price anyone is willing to pay and the lowest price anyone is willing to sell at across the protected venues.
Brokers measure the quality of the trades they execute for clients against this benchmark. Investors benefit from tighter spreads and greater competition between venues.
There are trade-offs. The rules encouraged the growth of high-speed trading, and the market has become more fragmented, with trades spread across many venues.
Critics argue that the system is too complex and may favour firms with the fastest technology, while supporters say it has cut costs for ordinary investors. For a non-specialist, the practical message is that the US stock market operates under a common rulebook designed to protect investors' prices.
When a broker talks about best execution or the NBBO, it is applying NMS principles. Other countries have their own frameworks, so the term is specific to the United States.
In practice
Real-world examples.
Example
An investor places a market order to buy 500 shares. Exchange A displays an offer of $20.00 and Exchange B displays an offer of $20.02. The broker's system must route the order to the better price, or match it, before filling any part at the higher price.
Example
A retail broker publishes a report showing that 95% of its customers' orders were filled at or better than the NBBO. The report uses the NMS benchmark to demonstrate best execution. A client reading it sees that the broker is monitored against a clear standard.
Example
A trading firm wants to quote a price of $15.0025 on a stock. The sub-penny rule prevents this for a stock priced above $1, so it must quote in whole cents. The firm adjusts its software to round to $15.00 or $15.01. Its compliance team adds the change to a log of rule updates.
Case study
Seen in the real world.
Harbor Point Brokerage is a fictional firm used in this illustrative story. A compliance officer there reviewed a sample of 10,000 customer orders and found that 3% had been executed at prices worse than the best displayed price on another venue. The cause was a delay in the firm's price feed, which meant its router worked from out-of-date quotes.
The firm replaced the feed and added a daily test that compared executions with the NBBO. Within three months the share of outside-the-best-price trades fell to 0.2%. The compliance officer reported the result to the board and added a standing exception report to monitor trade-throughs.
The compliance officer also shared the results with the firm's customers in a short note that explained what the NBBO is and how the broker checks against it. Clients responded positively, and the firm saw fewer queries about the prices they received.
Watch out
Common mistakes.
- Thinking NMS is a single exchange. It is a regulatory framework that connects many trading venues.
- Assuming it guarantees the best possible price in every case. It protects displayed, quickly accessible quotes and not every possible price.
- Using it as a global term. It refers to the US system, and other regions have their own rules.
Questions
People also ask.
What is Regulation NMS?
It is a set of SEC rules adopted in 2005 that deal with order protection, market access, minimum price increments and market data.
What is the NBBO?
It is the best bid and best offer available across protected venues, used as a reference for trade execution.
Who enforces the rules?
The Securities and Exchange Commission oversees them, along with self-regulatory organisations such as exchanges and FINRA.
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