The trade-reporting saga continues. Nasdaq's proposal for a trade reporting facility (TRF) will either blaze a new regulatory path for other exchanges or will steal a march on them. That's the nub of the debate over the TRF plan, which is crucial to Nasdaq winning final approval of the exchange by this summer.
The proposal, pending before the SEC, is critical for Nasdaq. That's because, without final approvals, it is unlikely to become fully operational. The exchange was recently okayed, but regulators stipulated that the TRF must be separately reviewed. Under the Nasdaq exchange application, most transactions would be executed using
traditional price-and-time priority as is the case now with all other national securities exchanges.
Nasdaq's exchange twist is that orders internalized by NASD broker-dealer members, orders that might not have price-time priority, would be reported through the new TRF. The facility would be jointly administered by Nasdaq and the NASD, using a limited liability corporation.
Nasdaq critics complain that the Nasdaq and its former parent are far too chummy. They say that is because Nasdaq is going to become one of the NASD's bigger clients.
The TRF joint venture between Nasdaq and its former parent, NASD, has triggered considerable controversy. For example, the plan calls for the money paid by broker-dealers for trade reporting services to go to Nasdaq. This includes crucial market data revenues. Nasdaq officials, who have consistently said they see no reason why the TRF won't be approved, have dismissed these criticisms.
Argument
Several of Nasdaq's critics, most of whom are competitors, said any successful TRF plan must ensure that revenues will not be retained by Nasdaq.
"Actually, we don't have a problem with the trade reporting facility itself," one TRF plan critic told Traders Magazine. "We just don't want a TRF that gives Nasdaq market data revenue attached to internalized prints. We also think that the SEC should let NASD keep the market data revenue and thereby reduce broker-dealer regulatory fees."
Nasdaq exchange critics are arguing that the new exchange is carrying many of the benefits of a utility/regulator into a new life as a for-profit exchange. But a Nasdaq official insisted that approval of the TRF plan entails no special privileges.
"We have specifically created the trade reporting facility to have a non-exclusive relationship with the NASD," according to Chris Concannon, executive vice president with Nasdaq. "The TRF has opened the way for any exchange in the U.S. to now conduct trade reporting business where they couldn't do this before," he added
Still, TRF critics also have publicly contended that the use of TRF revenues by Nasdaq would amount to an unearned "windfall."
This, they complain, would give Nasdaq a decided advantage over its competitors. That is unless they were also able to reach similar deals with the NASD that result in multiple TRFs.
Windfall?
"The big issue here," another TRF critic said, "is the windfall of unearned market data revenue that will be used by Nasdaq to pay for more print revenue by giving market data rebates. The issue is the revenue. It's not the facility itself."
Nasdaq critics have also complained that Nasdaq's existing ACT trade reporting system will unjustly generate tens of millions of dollars for the new exchange. They have argued that the printing of trades is not worth the amount of money Nasdaq would obtain through the TRF.
Nevertheless, Nasdaq officials, in filings and public comments, have repeatedly argued that these trade reporting revenues are not new. They already earn and receive these revenues.
Concannon, the Nasdaq official defending the TRF, said this is a business that Nasdaq already has.
"There's no new windfall. This is a business we have conducted through the NASD for some 35 years," he added.
In a recent quarterly filing, Nasdaq's net market data revenue, which it lists as market services, was $31.5 million on Nasdaq gross revenue of $220.4 million and net revenue of $130.6 million. That number excludes variable costs such as rebates and brokerage fees.
Those backing the TRF plan have argued again and again that the plan as now structured does not represent a violation of any securities laws.
A Nasdaq critic, who is also an official of a rival exchange that is trying to block the TRF plan, concurred that multiple TRFs may be the result of this regulatory fight.
For Everyone
"If they (Nasdaq) ever get this TRF, then we all are going to want this. And if we all get this kind of deals, it will drive down the price that trade reporting facilities can charge to zero or almost zero," the Nasdaq critic told Traders Magazine.
Here was a point on which defenders of the TRF and opponents, who have often traded sometimes-bitter charges in the press, actually agreed.
Some TRF defenders have taken a so-what' attitude on this issue. Indeed, they conceded a price war could break out. But they argue that wouldn't be bad because investors would be the winners. Nevertheless, one key lawmaker questioned if numerous TRFs would be a good thing (See sidebar).
Defenders of multiple TRFs have also emphasized that the Nasdaq exchange application stipulates that the TRF is not exclusive, so any exchange can follow Nasdaq's lead. This is a point that some in the trading industry are already acting on.
Clearly, supporters of the TRF are betting that the SEC is moving toward allowing multiple NASDs, or registered securities associations. They are building their case on one notion: Several exchanges have, or are moving toward, having print facilities similar to Nasdaq's ACT system.
Indeed, the Chicago Stock Exchange has proposed its own TRF (See Washington Watch item). National Stock Exchange officials were said to have verbally asked the NASD for "the same deal as the Nasdaq deal," one industry source told Traders Magazine. National Stock Exchange officials didn't return phone calls.
Another industry source, who has criticized the NYSE in the past, suggested that "before all of this is over I bet you that the NYSE will be putting in for its own trade reporting facility."
Indeed, one trading official said the NYSE, when it goes into gap-quote mode and puts up a block, is running a print facility in the form of an exchange. Gapping quotes are a feature in the NYSE's hybrid plan that allows an intermediary in a fast moving market to make a quote wide, not letting a trade go through, the trading official said. The trader is letting a large print come out within that gap quote. This is what is referred to as a clean cross. This is the same thing as an internalized print, he said.
Another point of contention for critics of the current TRF plan is its supposed conflict of interest. Plan critics say TRF approval should require that Nasdaq must spin off its ACT system.
"Archipelago was forced to give up its WAVE system in order to become an exchange. The same standard should be imposed on Nasdaq," said this official, who declined to be quoted by name.
Those in the business making the case for Nasdaq dismiss the comparison of WAVE to ACT. Several trading officials have said the two are unrelated. WAVE, they note, was an institutional agency broker. The SEC, they say, determined that markets shouldn't own institutional brokers or agency brokers. That was in an SEC policy, they said.
An industry spokesman, asked about this point, said, "ACT was a trade reporting business that was started by the NASD. And today the only license under the federal securities laws that allows trade reports to be submitted to the public market, in a non-price-time priority is the NASD license," he said. "If you read between the lines, it's not the trade reporting facility that the NYSE objects to; it's internalization," according to the industry spokesman (See Washington Watch item on internalization). He added that every large brokerage in the trading industry that conducts internalization has a stake in the approval or the possible change of the TRF plan. Some brokerage executives have also said that, without the internalization practice and without the use of a TRF, they will be hampered in their efforts to find liquidity.
"They'll be hurt when they have to go outside of an exchange to find liquidity," said one trading executive who supports multiple TRFs.
The NASD, at press time, had yet to file the TRF plan, but it was expected to do so soon. Nasdaq needs to have the review process start moving soon if it is to meet its deadlines.
A Nasdaq spokeswoman referred questions on the timing of the TRF application to the NASD. The latter didn't respond to repeated requests seeking comment.
Capitol Hill Takes an Interest in the TRF Battle
The proposed Nasdaq/NASD trade reporting facility (TRF) is under fire from an influential house member, even as he continues to support the exchange itself.
Congressman Richard Baker (R-La), the chairman of the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, predicts approval of the proposed TRF by the Securities and Exchange Commission will lead to a proliferation of similar facilities. And that could be bad public policy, according to Baker.
"The resulting proliferation of print facilities providing revenue and trade information to markets that have no nexus with the actual trades may contravene the public interest," Baker wrote in a letter to SEC Chairman Christopher Cox.
"If this approach is approved, other markets may have to follow suit simply in order to compete," he added.
Despite his questions about the TRF, Rep. Baker, in his letter, said he is still "fully supportive" of the Nasdaq exchange itself. But the exchange, the subcommittee chairman added, must be in compliance with rules that do not allow an exchange to take credit for trades that don't take place on an exchange.
