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September 1, 2011

Cover Story: Sweetening the Deal

Exchanges Step Up Their Rebating as Volume Slumps

By Peter Chapman

When the going gets tough, the tough slash prices.

In the case of the nation's stock exchanges, that means increasing rebates. With volume slumping, exchange operators are pulling out all the stops to reel in the big trading firms.

Volume in the first half of the year averaged 7.5 billion shares per day, down 20 percent from the same period last year. In July, the trend continued, as average daily volume slipped to 7 billion shares.

It is the brokers who supply those shares, so the exchanges must adapt to their straitened circumstances. In effect, that has meant paying them more for less.

In the current malaise, the exchanges are introducing new rebate programs and sweetening the terms of existing programs. They are adding new rebate tiers, reducing volume thresholds and, simply, increasing rebates.

Since January, the major exchange operators-NYSE Euronext, Nasdaq OMX Group, BATS Global Markets and Direct Edge-have introduced seven new rebate programs and improved the terms of five older programs.

Bryan Harkins

"The good news for the Street is that rate competition is as intense as ever," said Bryan Harkins, chief operating officer at Direct Edge. "It's helping to offset some of the market volume challenges."

Consider the changes in July alone. In that month, NYSE Arca introduced a new "step-up" rebate program that rewards traders who post more in a given month than they did in June. At the same time, Direct Edge's EDGX exchange reduced the threshold for its highest rebate from an average 38 million shares to 20 million shares per day. Also in July, Nasdaq permitted its members to consolidate the trading of their affiliates in order to reach higher rebate tiers. Finally, BATS Global Markets' BZX exchange tiered its rebate for the first time ever.

The situation harkens back to the 2007-2008 period of the first rebate war. Then exchanges and ECNs jacked up their payments by as much as 50 percent to within a penny of their take rates. That, in turn, left them with razor-thin spreads and heavily reliant on market data fees.

Spreads are coming under pressure this year, as well. Despite the moves on the rebate front, the exchanges are mostly not increasing their take fees. That's because most take rates are either at or bumping up against the federally mandated access fee cap of 30 cents per 100 shares.

By contrast, the top rebate at many of the exchanges has been moving steadily higher this year. At 34 cents per 100 shares, EDGX now has the highest. NYSE Arca is not too far behind, with a rebate of 32 cents for every 100 shares of displayed liquidity. For both exchanges, their highest rebates are greater than their highest take fees.