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April 2, 2012

Exchanges Set to Tax Heavy Quoters

By Peter Chapman

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  • Exchanges Set to Tax Heavy Quoters

Plans by two of the major exchange operators to reduce the amount of messages that pass through their systems have received mixed reviews.

Last month, both Direct Edge and Nasdaq OMX announced policies to curb what they consider to be excessive messaging by fining firms that don't produce enough trades relative to the messages they send in.

Direct Edge will reduce its rebate by $0.0001 per share for firms that trade only once for every 100 messages they transmit. Nasdaq will charge its members at least $0.001 per order if their non-marketable order-to-trade ratio exceeds 100-to-1. The policy affects only non-marketable orders, or those posted outside the national best bid and offer.

Both exchange operators say their new policies will result in a more efficient marketplace and reduce their members' message-processing burden. Both policies are aimed at heavy quoters, such as high-frequency trading firms. Both policies exempt market makers, however, even though some market-making firms are considered high-frequency trading shops.

Message traffic has rocketed in recent years, reaching an all-time high relative to shares traded last year. Studies have shown that the vast majority of all quotes are cancelled. Critics of the data deluge blame high-frequency traders for the glut.

Direct Edge's policy is slated to go into effect on May 1. Nasdaq's policy is to go into effect on June 1. Both proposals need the approval of the Securities and Exchange Commission. The regulator has recently indicated it favors such a rule. In February, at a press breakfast, SEC Chairman Mary Schapiro expressed concern over high-frequency trading and suggested it might be a good idea to curb the practice with charges for excessive cancellations.

Broker-dealers must keep up with the explosion in quotes by continuously investing in their message-processing infrastructure. Some, including Goldman Sachs and Investment Technology Group, have gone public with their ire over data overload, calling on the exchanges and the regulators to cut down on the traffic. They say it's not fair that some trading firms can use the system to excess without paying for the privilege.

ITG is appreciative of the exchanges' efforts. "We're generally supportive of this kind of approach," ITG executive Jamie Selway said. "Market data capacity and technological throughput are not free goods. Some bad behavior is driving up the costs for all."

Selway approves of Nasdaq's approach of just targeting quotes outside the NBBO, as it provides a disincentive for "excessive use of capacity, but doesn't put a tax on price discovery," he explained.

Oliver Sung, a trading official with Bank of America Merrill Lynch, also applauded the move by Direct Edge. "It's a disincentive for people who have a lot of orders that never execute," Sung said at this year's TradeTech Conference in New York. "So I think we're moving in the right direction."

Nasdaq's new policy is similar to that of Direct Edge, but different. Direct Edge is targeting all messages, including orders, cancellations and cancel/replace messages. Nasdaq is only targeting orders posted outside the national best bid and offer. Direct Edge is cutting rebates. Nasdaq is levying a fee. Nasdaq is also limiting its fines to those individual market participant identifiers that send in at least one million orders per day.