The National Association of Securities Dealers is planning to eliminate the double-counting of Nasdaq market makers' riskless principal trades.
Under a proposal filed by the NASD with the Securities and Exchange Commission, a market maker would only be required to report a riskless principal transaction as a single trade, even though the desk bought or sold shares from another dealer to fill the order the customer sent moments earlier.
The measure could save market makers an estimated $20 million annually, based on current trade volume. While it would reduce average reported daily share volume on Nasdaq by an estimated nine percent, market makers are not complaining.
An NASD official, who declined to be named, warned against unrealistic expectations, however, stressing that the rule would probably only bring a modest material benefit. "Traders will derive some benefit, but I would hate to see unreasonable expectations," the official said.
"A dealer is at risk 95 percent to 98 percent of the time," the official added. "The risk may be for two seconds, five seconds, a minute. If no one else steps in, it's his. In the last two to three weeks, people have learned there really is risk."
Sounding a warning, the NASD official said he would be amazed if the number of riskless trades suddenly skyrocketed under the new rule. "They [market makers] better not screw around and use trade reporting to save fees," the official added, referring to 31(a) transaction fees paid by traders on each sell trade they are currently required to report.
The reduction in overall transaction fees, in fact, is viewed as the major driving force behind the NASD's proposal.
On a broader front, traders are still fighting for wider relief from Section 31 fees which cover 31(a) fees on Nasdaq. [see story on page 12]
The NASD official said a trade typically becomes riskless as soon as the market maker has instructions to work a customer order.
"You can't measure risk in the number of seconds," the official explained. "At the time of execution, is the firm putting its capital at risk? If you have an order in hand, then you are not at risk."
The rule will cover the reporting of riskless principal transactions in the Nasdaq National Market, the Nasdaq SmallCap Market, Nasdaq convertible-debt securities, and non-Nasdaq OTC equity securities. The official stressed that the NASD will show "good judgment and sense" to make sure that firms can implement the new rule without problems.
The proposed rule amendment is said to have the support of SEC Chairman Arthur Levitt and SEC Director of Market Regulation Richard Lindsey.
If the amendments are approved, certain matching principal trades would be included within the definition of riskless, and reported to the public tape only once.
For instance, an amended rule would affect orders executed under the parameters of the order handling rules, which require market makers to display customer limit orders in their public quotes. Those orders are often filled by the market maker when that quote is accessed by another market participant.
Because market makers generally trade exclusively for a principal account, two separate transactions occur when they do a single trade one with a market participant and another directly with the customer. Both of these transactions are currently reported by market makers. The NASD is pressing to allow that type of trade to be reported as a single print.
In addition, the NASD now views a riskless principal trade as one that can involve two distinct orders the execution of one being dependent upon the receipt or execution of the other.
An amended rule would mean that a transaction can be defined as riskless when a market maker is holding an order from a customer, another member, the customer of another member, or any other entity including non-member broker dealers.
At the moment, market makers are deemed to be "at risk" when trading for their principal accounts. Non-market makers generally do not report all principal trades under current rules. No reporting is required for riskless trades.
The rules and resulting reports serve several purposes. They form the basis for public dissemination of last-sale transaction prices to the tape. Trade reports also are an essential part of the audit trail used by the NASD in fulfilling its regulatory responsibilities.
