Gone in Sixty Seconds or How Much Is Your Rebate Tax Bill?

One common source of resistance to the SEC’s proposal has been the consistent stream of “where’s the harm?” questions. Some industry participants insist that rebates are a boon for investors, and that removing them would result in poorer execution quality. Most in the industry, including some of the largest investors in the world, know this is a false narrative.

To corroborate the widely held belief that rebates cause investors harm,[1]IEX has studied and quantified one specific way rebates distort competition for executions: a silent, repetitive, systemic wealth transfer where some high-speed traders?—?and the stock exchanges who sell them speed advantages?—?are benefiting at everyone else’s expense. We call this the “Rebate Tax,” and it imposes significant costs on long-term investors.

Investors Suffer on Maker-Taker Exchanges

Here’s how it works: publicly available data shows that maker-taker exchanges (those which pay rebates for adding liquidity) have the highest market share and the longest lines to trade.

An exchange’s order book is comprised of limit orders that line up at their respective buy or sell prices, forming queues/lines at each price level. Orders at the front of a line will trade first, oftentimes without immediately moving the stock price in an adverse way. As an example, a small undersized marketable order that would not impact the supply/demand of a stock would trade with an order at the front of the line, and would be deemed a high-quality trade. However, orders at the end of the line wait longer to execute and are more likely to trade with larger marketable orders. Therefore, orders at the end of a long line are more likely to be adversely selected.

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