Nasdaq is on the precipice of changing the way some of its biggest customers trade options on the bourse.
The exchange operator has announced a plan to cut the fees it charges some of its biggest customers, according to a report by Reuters. The attempted move has proven controversial, sparking cries of outrage from both rivals and regulators.
Last October, Nasdaq told U.S. regulators that it wanted to offer cheaper trading for customers of one of its options exchanges, if their total volume of trading with all three of Nasdaq’s options exchanges was substantial.
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The Securities and Exchange Commission put the proposal on hold in November, and asked for comment on the proposal.
If approved, Reuters reported, the Nasdaq plan could have far-reaching effects on competition, pricing and complexity in options and stock markets. Rivals claim it would end a level playing field by favoring larger exchange companies that run a number of different marketplaces over smaller players.
In the current fragmented marketplace, there are well over 50 exchanges, ATSs and other venues where trading occurs in the U.S.
The standoff stems from an obscure feature of law that forces each individual exchange to offer the same pricing plans to all of its customers.
Because of the rule an exchange company cannot on the same market offer rebates favoring customers who place many orders while also giving discounts to customers who place a few very large orders, for example. Instead, the company has to set up different exchanges to meet the needs of different customers. Each exchange is supposed to compete with the others, even if they are owned by the same corporate parent.
Under Nasdaq’s proposal, Reuters said, the walls between those units would be effectively broken down. That’s what alarms smaller rivals and startups, who say that tearing down those barriers will allow Nasdaq and other established operators to offer cheaper pricing, stifling competition and entrenching the biggest exchange operators.
Reuters reported that in its public rebuttal to criticism, Nasdaq said some of its rivals were just looking to avoid competition. The operator said the SEC “should treat with substantial skepticism any argument by an exchange that a competitor should not be permitted to reduce its prices.”
There is no rule explicitly banning the practice of aggregating volume across exchanges to provide discounts. There are, however, laws stating that each exchange’s fees cannot be unfairly discriminatory or hinder competition.
Nasdaq declined comment when contacted by Reuters.
The Fallout
“It’s a dramatic departure from previous precedent,” said Jeromee Johnson, who runs the BATS Global Markets’ options exchange in an interview with Reuters.
The proposed pricing plan could be used “benevolently,” to lower prices for some firms, or it could be used “malevolently,” allowing exchanges to use the bundled rebates to gain “mini-monopolies” on certain segments of the market, said Bill O’Brien, chief executive at Direct Edge told Reuters. The proposal needs to be scrutinized, he added.
In scrutinizing the latest proposal, the regulator will consider whether it is anticompetitive for individual exchanges to act together to encourage trading activity, two people familiar with the SEC’s thinking said.
The regulator will also look at the potential impact of Nasdaq’s proposal on the principle of equitable allocation of fees, they said.
Nasdaq said the proposal would lead to lower trading costs, and is therefore pro-competitive – an argument that one of its biggest customers, hedge fund and market maker Citadel, supports. Further, any exchange that felt at a disadvantage by having just one platform could simply open other exchanges, and operate similar pricing formats, Nasdaq added.
Deutsche Boerse’s International Securities Exchange (ISE), which recently launched its second U.S. options exchange, told Reuters it isn’t as easy as that, warning that the process of getting its new platform off the ground took years and overall costs ran into the multiple millions of dollars.
“Can exchanges that supposedly compete against each other cooperate to establish joint fees?” ISE wrote in a letter to the SEC. “We believe that the answer is a resounding ‘No.'”
MIAX Options Exchange said it could not compete against a structure that leverages trading volume and fees over three competing exchanges.
The proposal “would severely hinder competition amongst options exchanges and damage the existing market structure that is built on competition and innovation,” MIAX told the SEC.
The SEC has until May 23 to make a decision, although that date could be extended, Reuters reported.
This story originally appeared on Reuters News Service
