Paid to Trade

“You’re giving the exchanges so much business, they should be paying you,” said Richard Keary of Global ETF Advisors in a June 2014 Financial Times article.

He was talking about Exchange Traded Funds, which drive big volumes for markets listing them, much like star athletes or Donald Trump. There’s the adage that the worth of a thing is what someone is willing to pay for it. Turns out ETFs are worth a lot to BATS Global Markets Inc. In 2014, BATS started giving free listings to ETFs with over 400,000 shares of average daily volume.

Now they’ve upped the ante.  Wall Street Journal reporter Bradley Hope in a Sep 30 article described BATS’ plan to pay as much as $400,000 annually for ETF listings. BATS now has 33 ETFs from iShares, ProShares and other sponsors. The gorilla is the NYSE’s Arca unit with over 1,600 listed derivatives.  The Nasdaq has about 180.  But BATS has found a secret sauce. It’s the biggest ETF trading venue by volume.

Exchanges profit on the opening and closing auctions. The exchange with the listing gets to hold the auction for that stock or ETF. During auctions, exchanges charge the same price to buy or sell, 10-15 cents per hundred shares, where the rest of the time they’re paying for liquidity or charging to consume it, about 29 cents each (that’s high-frequency trading at its purest, the exchanges incentivizing them to bring trades that price the whole market, making trading data valuable). Thus all the money is in the auction.

Now, what is money doing today? A great deal of it follows benchmarks like the S&P 500 or the Russell 2000. That’s indexes and ETFs. Both may also have options designed to, as the NYSE’s Arca says in its materials, “gain exposure to the performance of an index, hedge and protect a portfolio against a decline in assets, enhance returns on a portfolio [or] profit from the rise or fall of an ETF by taking advantage of leverage.”

What drives volume? Money with a mission to move daily, especially if it’s big enough to have options (or futures) too. That’s liquid ETFs. Most track underlying indexes. The best way to price benchmarks is in auctions, which offer a midpoint and minimize intermediary arbitrage. These prices often set net-asset-value calculations for indexes.

The Nasdaq is running opening and closing auctions.  BATS does too. Ditto the NYSE.  Arca, the electronic NYSE derivatives market, has three auctions.  In May this year, the SEC approved an NYSE request to hold midday auctions in low-volume stocks.

Auctions aggregate buy and sell interest. Fragmented markets (an oxymoron) do not.  And the most valuable investment vehicles driving this auction revitalization are ETFs. At BATS at least, they’re worth more than the underlying assets, stocks of companies.

If BATS wants ETFs, which are derived from underlying shares, so badly they’re willing to pay, and a market system built on a relentlessly moving best bid or offer is increasingly seeking the singularity of auction prices, what’s driving this market? Well, the uniformity of money tracking benchmarks, and derivatives.

ETFs are derivatives. They don’t listen to earnings calls or meet executives to hear the story. Now let’s think about this.  Nothing exists – ETFs, indexes, options and futures would be valueless chaff – without the 3,800 public companies comprising the US stock market. How is it the things derived from the assets – ETFs – are being paid to list, while the assets, the actual companies driving results and strategies making passive investment possible, are being charged?

And if you’re listed at the Nasdaq you don’t pay the NYSE when your shares trade there.  Ever thought about that?  The problem is public companies aren’t paying attention.  Otherwise they’d be asking why derivatives get paid to trade, and companies pay to trade.

The exchanges will say, “Oh but that would require a rule change.”  Fine. This is why we’ve been saying for ten years that public companies need to understand the market. Then you can start asking the right questions, like what’s setting my price?  And what am I paying the exchange for again?

It begins with comprehending structure.  We track it every day.