Nasdaq OMX plans to start penalizing trading firms that quote excessively.
Beginning June 1, Nasdaq will charge traders on its three exchanges a fee for posting what it considers an excessive number of orders away from the inside market. A market participant will be allowed to post up to 100 orders for every trade executed free of charge. Beyond that they will pay one-tenth of a cent or more per order as a penalty.
Nasdaq announced its new policy on its website last night, just hours after a similar policy was announced by competitor Direct Edge. Both exchanges have come under pressure by their members and regulators to curb the message traffic on their trading platforms.
“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.”
The moves come against a backdrop of increased high-frequency trading and surging message traffic. Brokers have blamed high-frequency shops for producing a glut of quotations and cancellations that they must pay for. The Securities and Exchange Commission has also expressed concern, suggesting that curbs on message traffic may be necessary.
In the past, exchanges have balked at imposing penalties on those members producing the most quotes, as they provide valuable liquidity. (See Traders Magazine, November 2011 issue.)
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 or offer. Direct Edge is cutting rebates. Nasdaq is levying a fee.
Importantly, both exchange operators are exempting registered market makers from their new rules. Nasdaq’s Golub says that market makers rarely post quotes outside the NBBO anyway. In fact, Nasdaq has a policy limiting the widths of dealer quotes. “The electronic market makers are not the ones putting in excessive messages away from the inside,” the exec said.
Message traffic has grown significantly in recent years, reaching an all time high relative to shares traded last year. Critics of the trend blame so-called high-frequency traders for the glut. Some of those are registered market makers.
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 concerns, calling on the exchanges and the regulators to reign in the fire hose of data. They say it’s not fair that some trading firms can use the system to excess without paying for the privilege.
ITG executive Jamie Selway says his firm is pleased with the exchanges’ initiatives. “We’re generally supportive of this kind of approach,” 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.
For some trading executives, the policy changes are non-events. Dan Mathisson, in charge of U.S. equity trading at Credit Suisse, says 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.
For Nasdaq, the new policy is its third initiative in the past 14 months to restrict excessive quoting. Its Investor Support Program, launched in 2010 on its flagship exchange, rewards firms with a higher rebate if they maintain an orders-to-executions ratio of 10-to-1. A program recently started on its PSX exchange requires orders to rest on its book for at least 100 milliseconds. The move is an attempt to discourage high-frequency shops from continually placing and cancelling orders on an exchange designed to trade large blocks.
Nasdaq operates three stock exchanges, including its flagship marketplace, the PSX exchange and Nasdaq OMX BX.
