The Market Data Battleground

Data fees are ridiculously expensive... at least thats what the brokers say.

Battleground [bat-l-ground]Noun: an area of contention, conflict, or hostile opposition.

Once a plain-vanilla add-on to an exchange offering, market data has evolved into a key battleground between market participants, i.e. the consumers of market data, and market operators, the producers of market data.

Some institutional trading firms say large exchange operators act monopolistically when it comes to market data – traders need the data, and its not available anywhere else, so theyre stuck paying too much.

Exchanges say market participants dont necessarily need to purchase their data, and data prices are simply a reflection of what the free market will bear. Exchanges have been besieged by competition from all sides in their core trade-execution business over the past decade, and data has stepped in as a much-needed growth area in revenue-challenged times.

Market data is a very contentious issue, said Dan Connell, managing director of market structure and technology at consultancy Greenwich Associates. It has been a contentious issue for years, if not tens of years.

The brokers are saying a couple of things, Connell told Markets Media. One, theres not enough oversight on the exchanges and their ability to control pricing for what is a required piece of information. Two, the brokers often bring up the fact that theyre really just buying back their own data. When you combine those two, it is certainly concerning for the broker community.

Bottom Line

Numbers tell the story of just how big data has become for exchange operators. In 2011, NYSE Group owner IntercontinentalExchanges data services fee revenue was $134 million, or 10% percent of total revenue. In 2015, data revenue was $871 million, or 26%.

We are seeing data and connectivity services increasingly linked to markets they serve, and as an exchange operator with significant amounts of proprietary data, we will continue to use this to enhance our valuation and analytical services to offer actionable information, ICE said in its 2015 annual report.

At Nasdaq, revenue from information services increased 17.4% between 2013 and 2015, compared with 10.2% for its broader market services business, which includes listings and technology.

Panel sessions at securities industry conferences are typically friendly affairs; I agree with… is perhaps the most frequently heard lead-in as an answer to a question. But there are exceptions. One exception is exchange CEO panels, which have been known to get a bit testy. Another exception is when the topic of market data is raised, and the rift between exchanges and brokers comes to the fore.

Exchanges are in a tight spot when it comes to market data. They dont want to alienate their core customers – brokers – by charging high fees for data, just because they can. But as for-profit, shareholder-owned entities, they also dont want to voluntarily rein in a highly lucrative business. Profit margins on data products are said to be as high as 70%.

That leaves the situation in a tenuous stalemate of sorts, where brokers complain and exchanges parry, but nothing really changes.

A recent legal decision portends more of the same is in store with regard to market data. In a June 1, 2016 order, chief administrative law judge Brenda Murray of the U.S. Securities and Exchange Commission found that significant competition constrains prices for depth-of-book data, and assertions that the fees increased costs for end-user investors were unsupported.

The order was a win for NYSE and Nasdaq, whose ArcaBook and Level 2 data feeds were the crux of the matter. The Securities Industry and Financial Markets Association, which brought the legal challenge on the premise that NYSE and Nasdaq data fees are too high and largely unfettered by competitive forces, said it would review the decision and evaluate its options.

Do brokers need to buy exchanges proprietary data feeds?

Technically, no. Theres no explicit rule that mandates a broker buy data feeds from NYSE, Nasdaq, Bats, or any other trading venue, for that matter. Brokers can instead use the Securities Information Processor, which is the industrys central, consolidated live stream and aggregator of every exchanges best bids, offers and trades.

But effectively, the answer is yes. Regulators have raised the bar on best-execution standards for brokers over the years, and the SIP – created in 1975 – is slow compared with the exchange product. So to the extent that a broker marking trade execution against a slower data feed is unacceptable, so is relying on the SIP and passing on exchanges data products.

The biggest brokers use exchange data feeds, which makes it incumbent on their smaller competitors to keep up and do the same in what one industry executive termed an unwritten rule.

IEX Factor

One potential market-data disruptor with regard to market data is IEX Group, which went live as an exchange in August, two months after its application was approved by the SEC. The new player – made famous by Michael Lewiss 2014 Flash Boys book – aims to differentiate itself via a 350-microsecond speed bump that is designed to negate the advantage of the highest-speed traders.

NYSE and Nasdaq opposed IEXs exchange application, and the exchange operators continue to speak out, asserting that the speed bump will add complexity to a market that is already too complex. IEX defends its model as a fairer marketplace; when the upstart goes on the offensive, market data fees charged by exchanges are one of its counterpunches.

We side with the brokers on this, said IEX Chief Executive Officer Brad Katsuyama. One, they are obligated by regulators to purchase market data from the exchanges, and the exchanges continue to charge more and more for providing the same service. Theres very little transparency into the costs that go behind producing this data.

And the ironic part is, the data isnt even the exchanges, Katsuyama told Markets Media. These are orders being sent by brokers and clients. Theyre being charged more and more to look at orders that they themselves are submitting. The exchange is just a distribution mechanism.

Katsuyama takes issue with the pricing structure of incumbent exchanges. Part of the reason exchanges charge so much for market data is because they pay billions of dollars in rebates every year for people to post bids and offers, he explained. Theres a short-term incentive in the form of a rebate, and a long-term increase in cost in the form of market data and access fees. I think in many ways rebates and market data are linked, because the exchange has to make up for the revenue it pays out in the form of rebates.

IEX backers include brokers, mutual funds, pension funds, hedge funds, academics, and market makers, according to Katsuyama. We have a very broad group of stakeholders and I think all of them in various ways look at the existing exchanges and say, something has to change, he said. The cost of data cant go up perpetually, and thats really whats happened. At some point I think its unsustainable.

In its nearly three-year history as an alternative trading system, IEX hasnt paid rebates or charged for market data, Katsuyama noted. Indeed, on its website, under Market Data Fees, the Internal Distribution Fee, External Distribution Fee, and Usage Fee are all listed as Free.

When asked whether IEX will continue giving away market data as an exchange rather than ATS operator, Katsuyama said for the foreseeable future, yes.

In the near term they will continue to give it away, to differentiate, said Connell of Greenwich Associates. I dont think the existing exchanges will change policies, because market data is such a significant part of their revenue.

IEX doesnt have data revenue, Connell continued. But I do suspect that as IEX grows and looks for new sources of revenue, they will at least look at their policy around exchange data.

Value Added

To be sure, exchange data on todays rapid-fire electronic market is a value-added product. If it were easy to replicate, presumably entrepreneurs would have developed their own solutions and would be out there selling it to brokers, undercutting exchanges in the process.

NYSE ArcaBook shows the full limit order book for Arca-traded securities on a real-time basis. Also included are data elements providing information to Arca opening, closing, and halt auctions, as well as indicative match price, match volume, auction imbalance, and market imbalance data.

All of the data is disseminated through data vendors or through a direct data feed originating from NYSE SFTI network utilizing a multicast feed. This product is meant to enhance market transparency and provide traders with a complete liquidity picture from a bellwether U.S. marketplace.

Nasdaqs Level 2 provides the top-of-file position for Nasdaq exchange participants. Introduced in 1983 as Nasdaq Quotation Dissemination Service (NQDS), in 2007 it expanded beyond Nasdaq-listed securities to include market participant depth in NYSE-, Amex- and regional exchange-listed securities.

Nasdaq one-upped Level 2 with its TotalView data feed, which provides a fuller view of market liquidity and market participants trading strategies. TotalView shows every quote and order at every price level in Nasdaq-, NYSE-, MKT- and regional-listed securities on Nasdaq, and it allows traders to view all displayed quotes and orders attributed to specific market participants, access total displayed anonymous interest, and see the total size of all displayed quotes and orders.

Regulators are in a difficult position. They are charged with ensuring that market data fees are fair and reasonable, but there is significant leeway in interpreting just what is fair and reasonable.

One sticking point is that while the SEC controls the pricing of the SIP, exchanges control its governance, which includes collecting and distributing market data. This creates a conflict of interest, as exchanges will generate more revenue as more traders seek alternatives to the SIP – which means proprietary exchange data feeds.

For its part, the SEC says it reviews market data fees. But they have been doing so for an ongoing basis for a long time now, so market participants do not expect any change for the foreseeable future.

It is said that the more things change, the more they stay the same. This is certainly the case when it comes to market data fees.

In an October 2004 speech about Regulation National Market System, Annette Nazareth, then director of the Division of Market Regulation at the SEC, spoke about market data fees to the Security Traders Associations 71st annual conference in Boca Raton, Florida. U.S. equity electronic market structure has changed substantially over the past 12 years – a span of three presidential terms – but if SEC Chair Mary Jo White made some of these same comments to a conference today, it would sound current.

Many (Reg NMS) commenters asked the Commission to consider the broader issue of the extent to which the amount being charged generally by the market data networks is reasonably related to the cost of producing the data, Nazareth said. These commenters argued that market data revenues were far too high to be reasonably related to the costs of producing market data.

As a threshold matter, it is clear that the issues surrounding market data, including its cost and wide availability to investors, are critically important, Nazareth continued. Market data is essential to investors and other market participants not physically present in a trading market, enabling them to make informed decisions when to buy and sell. It provides the basis for investment and portfolio decisions…In addition to providing transparency of buying and selling interest, consolidated data is the principal tool for addressing fragmentation of trading among many different market centers, and for facilitating the best execution of investor orders by their brokers.

Nazareth went on to note that exchanges market-data revenue represented a very small percentage of industry costs in 1998 – a measuring stick that no longer applies today. But then she made another point that could apply to todays market, that of exchanges reliance on data revenue.

Market data plays an important role in the funding of our self-regulatory system. There are limited sources of funding available to SROs. The primary sources are regulatory fees, transaction fees, listing fees, and market data fees, Nazareth said. Although SRO revenues have shrunk, SROs must continue to play the role that Congress assigned to them – front line regulators of the securities industry. Since satisfying this responsibility requires sufficient funding, market data revenue has become even more important now to SROs funding than it has been in the past.