It’s time for exchanges to get a bigger slice of the retail order flow pie, a pie that wholesalers have been gobbling up, some exchange officials say.
Several exchanges, pushing various rules changes, now expect greater retail flow, possibly negating big wholesalers’ internalization advantages.
For example, BATS Global Markets officials have just received Securities and Exchange Commission approval for the last piece of its retail price improvement (RPI) scheme, subpenny pricing. As a result, the exchange said Thursday it will launch its program through the BATS BYX Exchange on December 17.
“By enhancing price competition for retail orders, our goal is to provide retail customers with better execution prices while improving the overall quality of the BYX Exchange for all market participants,” said Joe Ratterman, president and CEO of BATS Global Markets.
The one-year pilot starts roughly 100 days after the August 1 debut of the first such program designed to give small price improvements to retail investors on off-exchange trades that are coordinated by an exchange.
That was the Retail Liquidity Program from NYSE Euronext and launched on the New York Stock Exchange and NYSE MKT exchange.
Nasdaq is working ona similar program which it has dubbed the “Retail Investor Auction.”
The Retail Price Improvement plan at BATS “is a program to try to attract retail, marketable orders back to display and exchanges,” said chief operating officer Chris Isaacson.
“This sets the stage for what I believe will be a fundamental shift in the way equity exchanges operate,” Ratterman wrote in an internal newsletter last summer.
The breakthrough idea is that “an exchange can now offer a differentiated level of service to some firms and not to others. Specifically, and understandably so, it’s the retail investor that theoretically stands to benefit from this new latitude afforded to the exchange to differentiate among its members,” Ratterman wrote.
Here’s how BATS officials say they will be giving the individual investor a better deal.
BATS will allow retail orders asking for price improvement to be matched, off-exchange, against orders from customers of brokers and other parties designated as Retail Member Organizations who are willing to provide it, before the orders go onto its BYX Exchange for general trading.
The orders get matched at a multiple price levels, with the first to come in getting the best prices, BATS officials said.
Only Retail Member Organizations (RMOs) would be able to submit orders for price improvement. The retail investor would end up with a price at least a tenth of a cent better than what mutual funds, institutional investors, brokers or other market participants would get, according to BATS.
The average price improvement in the competing program from NYSE was 15 hundredths of a cent, in the week from Nov. 16 to Nov. 23, according to statistics it keeps on Retail Liquidity Trading on its website.
Such a retail order, Bats said in filing with the SEC would be an agency order submitted by an RMO.
And that’s “provided that no change is made to the terms of the order with respect to price or side of the market, and the order does not originate from a trading algorithm or any other computerized technology,” according to the filing.
The RPI approval has an exemption from Rule 612 of Regulation NMS, which covers subpenny quoting. That’s because the BATS plan contains a provision that allows a BYX Exchange member to submit RPI orders that offer price improvement in $0.001 increments to retail orders submitted by RMOs.
Isaacson makes no apologies for the relief granted on subpennies, arguing it evens the field. The NYSE program was the first operated by an exchange to be granted subpenny ticks.
“Retail investors are today getting sub penny price improvement from wholesalers,’’ Isaacson said. “And they are often getting it at less than a tenth of a cent, which is the minimum RPI increment.”
Both exchanges agree on one point: Price improvement within an exchange environment means better value for the individual investor.
The programs, they said, will provide “new economic incentives and assures greater transparency, liquidity and competition throughout the U.S. cash equities marketplace,” Joe Mecane, NYSE Euronext executive vice president, recently told Traders Magazine.
But wholesalers contend they obtain flow because they provide value.
“What is missing from the [exchange] model is the desk that is there to answer questions about order flow,” Greg Tusar, head of electronic trading at Goldman Sachs said at an industry conference this year.
“Their service model,” Tusar predicted in addressing these exchange proposals, “will cause it to struggle.”
