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Why Do Exchanges Own Multiple Licenses? It's Not Hard To See, Look at the SEC

Traders Magazine Online News, November 8, 2018

Richard Repetto

In this recent research note, Sandler O'Neill + Partners, L.P. Principal Richard Repetto examines why the public exchange operators hold multiple licenses and that rationale behind this phenomenon.

Here is the note in its entirety:

The three largest equity exchanges own/control 12 exchange licenses. The CBOE, ICE and Nasdaq own collectively 12 exchange licenses or "medallions" as they are referred to. Some have speculated they have chosen not to consolidate these exchanges/licenses in order to gain more market data and connectivity fees. We disagree. We believe the reason why they own multiple medallions is mostly driven by SEC regulation/rules and to give customers choice. This note outlines three reasons why the large exchanges maintain multiple exchange licenses/medallions.

First, the SEC has mandated exchanges treat all customers the same. Said another way, each exchange medallion must have a similar structure or market model and treat customers in a similar manner (not segment customers). For example, the normal execution prioritization structure is called “PRICE TIME” where if you are equal to the best price, your order is prioritized based on the TIME it was placed. In other words, if the best bid is $10, and you place a bid order for $10 at 10:00 am, and another bid order is placed on the exchange for $10 at 10:05 or after your order arrives, the first order will get prioritized/executed first. Seems fair right? … This is the way the vast majority of exchanges models work with "PRICE TIME" priority. But there are different market models, which we discuss below.

There is another prioritization structure called "PRICE SIZE". So as long as you are equal to best price, your order is prioritized based on the SIZE of your order. In other words, if the best bid is $10, then if you place a bid order for $10 for 100 shares at 10:00 am, and then another order comes in at 10:05 am after yours with a $10 bid for 1,000 shares, the 1,000 share order would get executed/prioritized first. Time doesn’t matter in this structure, but the size of your order does. Certain large institutional customers, who want to move size, like this structure.

And there are different pricing structures or market models. There's the popular “maker taker” market model where the taker of liquidity pays the execution charge and the provider of liquidity gets a rebate. This is the market model most exchanges use. In contrast, there’s also what is called an “inverted model” where the taker of liquidity gets a rebate and the provider or maker of liquidity gets charged (i.e. the reverse of the maker taker model). This sounds strange but in certain circumstances traders are willing to pay to have liquidity removed against them. Bottomline, the first reason why exchanges own multiple medallions is because of the SEC, who mandates that the exchanges must treat customers the same (i.e. not make aspects of the market model available to some and not available to others) and in just rare exceptions allowed different exchange market models or customer segmentation within a single exchange license/medallion.

Exchange Medallions and Pricing Models/Differentiators

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