The industry might have rung out 2014 discussing the “grand compromise” on the US equity market structure led by the Intercontinental Exchange that would lower access fees in exchange for a trade-at rule, but BATS Global Trading wasted no time in the new to offers its market-structure alternative.
In an open letter to the industry, exchange CEO Joe Ratterman and president Chris Concannon argue against the compromise as a bad deal for investors despite it being a win-win for exchange operators and broker-dealers.
“[I]nvestors will likely pay more both in the form of potentially wider spreads as well as fewer and inferior execution choices resulting from restrictions on competition,” they wrote.
The pair suggests that exchanges should determine their access fees, and associated rebates, using a tiered price model based on an issue’s liquidity. For example, the most liquid stocks could have a five cent per 100 share, or $0.0005 per share, and more illiquid a stock is, greater its access fee.
They also recommend that alternative trading system (ATS) operators be required to disclose the operation rules of their platforms, descriptions of available order types, transparent eligibility guidelines, participant pricing tiers, order routing logic, and eligible routing destinations as well as expanding Rule 605 and 606 reports to include execution quality on a dealer-by-dealer basis.
None of these ideas are a real departure from the industry’s ongoing market-transparency and market-structure conversations.
What is new, is their idea of stripping Regulation NMS trade-through protection and shares of the consolidated tape revenue from any self-regulator organization (SRO) or publicly displayed ATS that does not achieve more than one percent of the daily consolidated tape volume over a rolling three-month period.
The current Regulation NMS structure artificially subsidizes competition and encourages further market complexity since it costs existing exchange operators almost nothing to mint a new exchange while broker-dealers could face substantial cost connecting to the new venue, Ratterman and Concannon argue.
Which exchanges would be affected?
According to the latest Tabb Liquidity Matrix, November 2014, the immediate losers would be NYSE MKT, Chicago Stock Exchange (CHX), and Nasdaq PSX, which have a 0.3%, 0.4%, and 0.7% market share respectively.
The market shares for the four equities exchange that BATS operates are well above the proposed 1% threshold – BZX (7.7%), EDGX (6.1%) BYX (3.1%), and EDGA (2.1%).
If the Securities and Exchange Commission implements this regulation, it would liberate about 1.4% of current liquidity, which the remaining exchanges would divide. However, it would remove three protected quotes that help tighten the overall spreads.
Additionally, it would raise a significant barrier-to-entry for potential new exchange operators if they needed to capture 1% daily volume within the first quarter of their operation to receive trade-through protection.
Competition always breeds innovation and stripping away the trade-through rule for the smallest exchanges guarantees that the US equities markets will remain a triumvirate.