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.
“We’re not telling people they can’t quote, that they can’t enter orders away from the inside,” Todd Golub, head of strategy and product development in Nasdaq’s transaction services division, told Traders Magazine. “We’re simply saying that if you were to do this at a very high rate, or excessively, then we will impose upon you a small fee.”
In the past, exchanges have balked at imposing penalties on those members producing the most quotes, as they provide valuable liquidity. (See Traders Magazine story from 2011.)
Not everyone is convinced the new policies are sound. At least one brokerage executive said they were misguided. “Cancel fees are not going to have the intended effect,” David Margulies, an executive with Weeden & Co, said at TradeTech. “Cancel fees depend on the threshold. So, even standard algos have pretty high cancelation rates, depending on the strategy. Will that be taxed? We don’t think any of this makes sense.”
Another trading official is skeptical the intended benefits will materialize. Adam Mazur, an executive with Goldman Sachs, wondered if the moves were simply a public relations ploy or would actually improve the marketplace.
“It will be interesting to see how this develops,” Mazur said of the Direct Edge policy at TradeTech. “I mean what percent of the decision to do this was P.R. versus what percentage was to incentivize behavior and to change behavior in order to reduce the message count?”
Mazur noted the exchanges themselves were the primary beneficiaries of the tremendous flow of trade messages. They have the infrastructure to handle them and they profit from them. “Clearly they would prefer a high execution count,” Mazur said. “Do they think it is the right thing to do because they get a P.R. benefit associated with that? Or do they think fundamentally that reducing the number of orders to the number of executions is ultimately a good thing for the market?”
For some trading executives, the policy changes are non-events. Dan Mathisson, in charge of U.S. equity trading at Credit Suisse, said the exchanges should be free to experiment with changes to their businesses, but message capacity is not an issue for his firm. “We can easily handle the current message rate,” Mathisson said.
Who’s Next?
Will NYSE Euronext and BATS Exchange follow in the footsteps of Direct Edge and Nasdaq, and fine their members for excessive quoting and cancelling? A spokesperson for NYSE said: “We have not made any determinations at this time. But we continuously evaluate the market, customer needs and competitive actions, and any changes made will address these considerations.” BATS would not comment, citing the quiet period before its initial public offering. Sources close to the exchange operator, however, tell Traders Magazine BATS is considering possible options to reduce message traffic.
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