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Is Market Structure Tied up in Knots?

Traders Magazine Online News, December 4, 2017

Ivy Schmerken

With a new head of trading and markets at the SEC, there is optimism that some of the complex market structure issues – such as make-taker incentives and sky-high market data costs — will be looked at in 2018.  As these issues wait to be settled, buy-side traders are also grappling with the EU’s MiFID II  rules on unbundling research payments from executions.

Here are some key takeaways on what matters to buy-side and sell-side traders, as discussed at Traders’ Magazine’s Second Inaugural Market Structure Equity Town Hall.

Maker Taker: Dead or Alive?

After a decade of debate, the SEC is expected to roll out an Access-Fee pilot that relates to maker-taker pricing incentives. A vote by the SEC is imminent, according to two people who spoke at the Trader’s market structure equity town hall held on Nov. 7. SEC Chairman Jay Clayton has indicated he will green light the pilot to test the impact of reduced access fees on exchanges, which was recommended by the SEC’s Equity Market Structure Advisory Committee (EMSAC) in 2016.

Rebates are paid to brokers as an incentive to post prices on exchange platforms, which helps attract more order flow, while others are charged an access fee for taking or removing bids and offers on their electronic trading venues. The difference between the access fee for takers of liquidity and the rebates for makers of liquidity is kept as revenues for exchanges.

Critics of the practice say the incentives motivate brokers to route client orders to platforms paying the highest rebates, which leads to order routing conflicts of interest.

As proposed, the EMSAC pilot will not eliminate rebates or take fees, but it will test the impact that reduced access fees have on liquidity.

Exchanges are paying rebates for adding liquidity that range between 12 cents and 33 cents per 100 shares, according to a study presented by  IEX. The pilot will lower the cap on access fees for different groups of stocks to 20 cents, 10 cents, and 2 cents per 100 shares.

However, several equity-trading executives at the Traders’ Town Hall were skeptical of the pilot, pointing to results from the small-cap tick pilot, which led to increased spreads, higher trading costs and increased routing to inverted venues.

If fees are simply reduced, then market makers will  lose the rebates and spreads will widen, and probably not much will be accomplished, predicted a sell-side executive who was skeptical of how much the pilot would accomplish.

Nevertheless, the sell-side observer said the pilot was worth doing to address conflicts of interest that are of concern to the buy side as this will build up their confidence.  However, some may argue it’s better to first address the conflicts through order routing disclosures, the sell-side executive noted.

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