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While the US equity markets are the most liquid and efficient markets in the world, they are also among the most regulated ones. In 2022 and 2023, the Securities and Exchange Commission (SEC) made several proposals to change US market structure – order competition, tick size and access fee reforms, Rule 605 of Regulation NMS, best execution and volume-based pricing tiers at exchanges for agency and riskless principal trades.
On March 6, 2024 the SEC adopted amendments to disclosure requirements under Rule 605. Now, heading into Q2 2024, US broker-dealers are anticipating another decision by the SEC, predicting that tick size and access fee reforms could be the next ones adopted.
As such, a representative from BLOX Markets, building a trading platform geared towards retail investors, foresees that the Tick Size & Access fee proposal will likely be “the next retail equity market structure rule to be adopted”. This anticipation is based on the comments provided by the SEC during the Bloomberg Equities Market Structure conference last week, and BLOX Markets anticipates adoption in Q2 based on feedback from the street.
The Commission proposed to reduce the existing cap on fees to access exchange quotes from $0.003 per share, or “30 mils” to $0.001, or “10 mils”, for almost all stocks. And the majority of commenters addressing access fees support a reduction in the access fee cap.
Joe Saluzzi, Partner, Co-Founder and Co-Head of Equity Trading at Themis Trading, said: “We support the lowering of access fees and believe that this change will be a win for long-term investors.”
Since Reg NMS was enacted in 2007, the major exchanges have been subsidizing low quality liquidity which often disappears whenever there is the potential for adverse selection, he said.
According to Saluzzi, reducing access fees will cause rebates to be reduced which should decrease the amount of low-quality liquidity. “Access fee reduction should have the added benefit of eliminating some complex order types and low-cost order routing strategies,” he said.
“Either way we look at it, this proposal should benefit the long-term investor,” he stressed.
Derrick Chan, Head of Equities at Fidelity Institutional, added: “We strongly support regulatory initiatives that result in better outcomes for investors, drive competition, and lead to more efficient markets.”
He noted that access fees must be looked at within the context of all of the SEC’s market structure proposals, “because they are all deeply intertwined”.
“I do not see access fees being a big issue for the equity markets. Broadly speaking, the current 30 mil access fee cap helps improve liquidity and quoted spreads for investors,” he said.
“At the same time, we support a reduction in access fees in certain segments of the market that is commensurate with a targeted reduction in tick sizes for stocks that are tick constrained,” Chan said.
For example, he said, if the minimum quoting increment for tick constrained NMS securities trading at or above $1/share is lowered to 50 mils (from current 1 cent), “we think that the access fee should be halved, or reduced from the current fee of 30 mils under 1 cent to 15 mils under a 50-mil tick”.
Chan said that his primary concern is around a broad reduction to the access fee, which could “harm liquidity and widen spreads with little clear benefit”.
“Similarly, while the access fee reduction may seem to lower costs, I don’t see a direct benefit to retail investors who already receive an effective spread on marketable orders that is much tighter than the quoted spread and typically free of charge – neither of which would be expected to change under the SEC’s proposal,” he said.
According to Chan, if the SEC’s access fee changes are adopted as proposed, institutional brokers who provide cost plus pricing to their customers will likely be insulated from the fee changes aside from some increases in billing complexity.
“However, institutional brokers who provide all in commission pricing could see their costs go down,” he said.
“The main benefit I see is when paired with a targeted reduction in tick sizes for tick-constrained names from 1 cent to 0.5 cents, it would prevent potentially distortive trading dynamics, like locked or crossed markets,” Chan said.
A reduction in access fees is also likely to lower fees for institutional brokers whose customers are net takers of liquidity, he added.
Saluzzi said that volumes that have been lost to off-exchange venues may migrate back to the lit exchanges since these exchanges will now be more competitively priced.
However, rather than just a reduction in access fees, Themis Trading would also have preferred to see an elimination of rebates, Saluzzi said. “We think a flat take/take fee model would have been a better proposal,” he said.
“This model would ensure exchanges still get compensated fairly for the service provided while at the same time eliminate most order routing conflicts,” he added.
If brokers are following best execution guidelines, they should not be affected by this change, Saluzzi said. “Brokers should be agnostic to access fees/rebates and should route to the venue where they will receive best execution,” he said.
Benefits and Concerns
Jeff O’Connor, Liquidnet’s Head of Market Structure and Co-head of Coverage, Americas, said that the cap of access fees can effectively lower the fees exchanges receive for matching orders at auction to levels below the payment wholesalers make to brokerages in exchange for execution of their retail volume.
“This reduction in margins could lead to the exit of SDP participation, removing the current structure of zero commission trading and accessibility/liquidity and guaranteed execution for the retail participant,” he said.
According to O’Connor, the spirit of the proposal is to enhance competition, but forcing the hand of industry participants to adopt a system that prevents market forces determining the cost of executing a trade, can be argued as anti-competitive.
He noted that the retail trader currently enjoys zero commission trading, obtainable markets, unlimited size in 10,000+ listed stocks and ETF’s, at prices that are better than institutions receive.
“Adding complexity and regulation threatens to hurt the retail participant, and the larger the forced reduction in access fees, the larger the lost presence of the retail wholesalers will impact execution quality and liquidity,” he argued.
O’Connor pointed out that broker-dealers route, or should route, in a price agnostic fashion. “Through a host of execution quality metrics, a broker dealers’ routing is based on their constant review of the best venue partners – offering a mix of both liquidity and performance,” he said.
“Data/analysis offers transparent performance of a venue (exchanges, ATS’s), and if a venue is underperforming, the spigot is reduced until ultimately closed altogether,” he said.
According to O’Connor, it is always in the best interest of a venue to outperform its peers because that behavior will produce more flow.
“A reduction in access fees will not change this analysis and the better venues will rise to the top,” he said.
The proposed equity market structure changes could narrow spreads resulting in reduced profitability for wholesale market makers, said the representative from BLOX Markets.
“If wholesale market makers presently receive top-tier rebates of about 30 mils from US exchanges, a potential reduction to 10 mils or 5 mils tomorrow could negatively impact their profits, or the rebate passed on to the end broker,” said the representative from BLOX Markets.
“If the profits of the wholesale market makers are negatively impacted because of reduced spreads, this could disrupt the payment for order flow (PFOF) relationship with retail brokers.”
“The proposed equity market structure changes may strain the payment for order flow (PFOF) relationship between wholesale market makers and retail brokers, potentially leading to increased competition for retail order flow, aligning with the fundamental objectives of the SEC,” stated the representative from BLOX Markets.
Chan further said it is hard to know exactly where the SEC will end up on this topic, but brokers can review their technology, risk controls, pricing models and trading strategies to see if they are able to adapt to evolving access fee thresholds.
“Depending on the scope of the rules that are finalized, investor education may be required to ensure that customers are reasonably able to operate under the new rules,” he said.
“This is less directly impactful to retail for changes to access fees but will have significant impact if other proposals such as tick sizes and round lot reforms are adopted,” he concluded.
