Let us make a retail deal, too.
That, in essence, is what Direct Edge wants from regulators for its exchange.
It asks, in a new rule filing with the Securities and Exchange Commission, for the ability to discriminate on retail orders, but on a public exchange.
Direct Edge hopes to attract more retail order flow, by getting market participants to designate which orders are Retail Orders and give senders of those orders a rebate.
This will help bring in orders, exchange officials say, that otherwise might get diverted to brokers’ internal pools of potentially matching orders and other off-exchange venues. These venues, they contend, don’t give the average investor as good a deal as Direct Edge will.
“The Exchange believes that consumer protection and transparency is promoted by rewarding displayed liquidity on exchanges over off-exchange executions,” according to the Direct Edge filing.
The New York Stock Exchange initiated a Retail Liquidity Program on August 1 that incorporates non-displayed orders, matching retail orders seeking price improvement with institutional orders in a cross between a lit and dark pool of orders. BATS Global Markets followed this week with a similar Retail Price Improvement plan that debuts December 17.
In its approach, Direct Edge asks the Securities and Exchange Commission to let it create new classifications for exchange members to use to designate what are Retail Orders. The ZA tag is for retail orders that add liquidity and the ZR tag is for orders thar remove it.
These orders would have a “financial incentive,” according to the filing.
ZA orders that add liquidity would receive a rebate of $0.0032 per share. ZR orders that remove liquidity would get a rebate of $0.0030 per share.
This retail liquidity comes from broker-dealers, but they are retail broker-dealers, says Bryan Christian, head of sales for Direct Edge. The brokerages are expected to pass on the discounts.
Why offer a discount for adding and removing liquidity from the exchange?
Direct Edge officials, in their filing, says many retail orders are executed over the counter where average investors don’t have the professional savvy to get the best deals. So it is “appropriate” to bring flow back to the exchange.
They also justify their attempt to obtain more retail business by arguing that more displayed order is “a public good,” according to the filing. Direct Edge officials maintain this provides more price transparency and public price discovery. Those, they say, it will ultimately lead to substantial reductions in transaction costs.”
BATS, like Direct Edge, said its program is designed “to attract retail marketable orders back to display (markets) and exchanges,’’ says Chris Isaacson, COO for Bats.
But Direct Edge wants to put some distance between itself other exchanges’ plans by the way it is going to offer a discount to retail business.
A difference with the competing exchanges all seeking more of the retail investor’s business, Christian adds, is Direct Edge’s “tagging”, or identification, of retail orders.
“Basically, we’re saying that, if you’re a retail broker-dealer, and your send me a retail order, down you’re going to tag it. You’re going to tell me it’s a retail order,” according to Christian
Christian says this program is less of a change for Direct Exchange than for other exchanges.
“We as an exchange have always had retail limit orders in our books. And it has been part of our mission to grow liquidity with retail limit orders,” Christian said.
He said the NYSE RPL is a separate form of liquidity that does not occur on its main market, where orders are displayed for all to see.
Christian added that Direct Edge’s program is “within our displayed market. And it is also a way that we continue to segment the volume in our book.”
Nevertheless, all of these exchanges, having to survive on weak volume, are seeking ways of finding increased retail business.
For example, William O’Brien, CEO of Direct Edge, recently said U.S. consolidated tape volume was down 17 percent for the year. In a meeting with Sandler O’Neill + Partners late last month, O’Brien also predicted 2013 volume will be “roughly flat” and that his firm is looking for new revenue sources.
Direct Edge, O’Brien told Sandler O’Neill, hopes strong retail performance will help.
“Direct Edge is the #1 or #2 routing destination among exchanges for the highly valuable order flow of retail brokers such as AMTD, Fidelity and Scottrade. Direct Edge is targeting 15-20 percent revenue capture increase in 2013,” O”Brien told Sandler O’Neill + Partners. But Direct Edge will likely need regulatory approval if it is to meet its goals.
So Direct Edge, in trying to swing the SEC, believes that it can make its case for price discrimination, or a “financial incentive,” for retail orders by citing the precedent of discriminating in favor of retail clients.
“The Commission has previously recognized,” Direct Edge wrote referring to the Euronext/NYSE order, “that the markets generally distinguish between individual retail investors, whose orders are considered desirable by liquidity providers because such retail investors are presumed on average to be less informed about short-term price movements, and professional traders, whose orders are presumed to be more informed.”
And that, Direct Edge and other exchange officials hope, will provide a signal change in how regulators look at exchanges.
“This sets the stage for what I believe will be a fundamental shift in the way equity exchanges operate,” wrote Joe Ratterman, president and chief executive officer of Bats Global Markets after reviewing the Euronext/NYSE order in an internal newsletter last summer.
“Core and foundational to the approved RLP rule is the new concept that an exchange can now offer a differentiated level of service to some firms and not to others,” Ratterman continued. “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.”
