Last year, I wrote a 10-page recommendation letter to the SEC covering various market structure topics. The key points were as follow:
- Recalibration of the access fee cap. A must if order protection, best execution rules and other NMS provisions remain as-is. The cap is, in essence, the maximum toleration of exploitation. Bad behaviors will still be nourished and abusers will seek alternate ways to circumvent the control.
- Conflicts and disputes would be better resolved through the market. Order protection and access rules might be able to rollback by having a new rule to ban exchanges, alternative trading systems, and internalizers from running data and technology businesses (mutually exclusive).
- This separation replaces the wickedness of a distorted economy of scope with efficiency gains (fewer fights, more cooperation, and better economy of scale) via better delineation of rights and it will help preserve healthy competition.
- Enable trading platforms to shape the markets and own up to the consequences of what they design. SROs will set boundaries for market-makers and give out inspection stickers.
- Market-Makers privileges will be auctioned where designated G-SIBs / SIFIs will enjoy rights to handle complex activities that match their market-making specialties and obligations and fix the everybody owns, nobody owns behaviors. Leverages HFTs ability to response in a timely fashion to flash warnings and liquidity crunch.
- If these separation and realignment suggestions can be adopted, consolidated audit trail should be revised for better market surveillance using stream analytics in real-time, and the economic resources devoted to in this access fee pilot can be saved and market integrity will be revitalized!
Things have evolved much lately, especially that nine core market participants (namely Morgan Stanley, UBS, Citadel Securities, Virtu, Charles Schwab, E-Trade, TD Ameritrade, Fidelity Brokerage, and Bank of America Merrill Lynch) vowed to establish the Members Exchange (MEMX), approval of Long-Term Stock Exchange (LTSE), and Miami Internationals Equity Exchange (MIAX) set to launch within a year. These may disrupt the SECs plan to adopt an access fee pilot. Lets envisage how the industry should move forward from here.
The access fee pilot is a big deal because it involves recalibration of maximum rebates that exchanges can offer and huge profits are at stake. NYSE, NASDAQ, and CBOE Global Markets hinted they would sue the SEC and did just that as the pilot test is about to start. High frequency trading firms (HFT) as receivers of the rebates are also against it. IEX and some buy-side firms are supporters of the pilot citing conflict of interest among other concerns. The pilot is expected to have significant order-routing implications, and there are various difficulties to carry out the experiment.
In my opinion, the pilots analysis may cost a few million (at most). The academics are fond of grabbing hold to more data for their research, while the pilot would be a substantial cost to everyone because of the added complexity to the market and there are costs for all market participants to adapt to the new norms. Therefore, I wonder: is it necessary to actually run the pilot when its objectives have already achieved? For that, I mean the SEC has already solicited lots of comments and will gather sufficient pre-pilot data, that helps to gauge the relative strengths between disputed parties for a force-field analysis, as well as declared that they are the one in-charge to discipline any abusers. In my opinion, transaction fees are merely one symptom of market inefficiency and ineffectiveness. Instead of treating symptoms that may cause other unintended consequences, I advocate for a more holistic approach to discern and pin point the 21st century market structure issues.
Now, lets talk about MEMX. Its two HFT members – Virtu and Citadel Securities, together account for approximately 40 percent of daily US trading flow. In other words, if the existence of IEX has any significant impact (which currently has less than 3% market share) in the Exchange space, then MEMX would likely be fifteen times or more in size of a disruption. That being said, MEMXs nine core members are likely receivers of the super tiers of 32 mils (cents/share) from high-rebate Exchanges. Then, why would they give up such lucrative and exclusive incentives to breakaway and start a new Exchange? How likely that they want to hand out higher rebate than 32 mils or provide more clients with access to the 32-mil top tier? Many indeed pointed to the continuous rise in market data cost as the obvious reason for MEMX and other new exchanges formation, which I dont disagree. However, I think there are other unobvious reasons which attribute to the reshaping of equity market, and I will elaborate in my upcoming series of articles. Stay tuned.
By Kelvin To, Founder and President of Data Boiler Technologies
