Tagged: access fees

Paid Access

A day ski pass to Vail will now set you back $160-$190. It’s rich but I’m glad the SEC isn’t studying skiing access fees. It is however about to consider trading access fees and you should know, public companies and investors. These are the gears of the market.

We all probably suppose stock exchanges make money by owning turf and controlling access. Right? Pete Seibert, Earl Eaton and their Denver investors had a similar ski vision when in 1962 they bought a hunk of Colorado mountain down from the pass through which Charles Vail had run Highway 6. Control turf, charge for access.

In stock trading it started that way too. The Buttonwood Agreement by 24 brokers in 1792 that became the NYSE was carving out turf. Brokers agreed to give each other first look at customer orders and to charge a minimum commission.

This became the stock-exchange model. To trade at one, you had to have access, like a ski pass. Floor firms were called two-dollar brokers, the minimum commission. If you wanted to offer customers more services – say, beer at Fraunces Tavern with a stock trade – you could charge more. But not less.  No undercutting on price.

In the ski business, Nederland, Loveland, Wolf Creek and other ski slopes along the continental divide will undercut, letting you in for half Vail’s cost – but Vail wraps world-class value-adds around its access fees, like Mountain Standard and The Sebastian.

Suppose all the ski resorts could charge only a maximum rate for passes and were forced to send their customers to any mountain having a better price.  It would be inconvenient for travelers arriving in Vail via I-70 to learn that, no, the best ski price is now at Purgatory in Durango, five hours by car.

And it would be like today’s stock market (save for speed). The three big exchange groups, plus the newest entrant IEX, and tiny Chicago Stock Exchange, comprising currently 12 separate market centers, can charge a maximum price of $0.30/100 shares for access to trade. And still they all undercut on price.

That’s because rules require trades to match between the marketwide Best Bid or Offer (BBO) – the best price. As Vail would do in our imaginary scenario, exchanges must continually send their customers to another exchange with the best price.

How to set the best price? You can only cut price so much.  More people will still go to Vail because it’s close to Denver on the Interstate, than to Purgatory, halfway between Montrose, CO and Farmington, NM off highway 550.

Now suppose Purgatory paid to chopper you in from Vail. It might not move you out of The Sebastian, but you’d again have the stock exchanges today. While access fees are capped (and undercut), exchanges can pay traders to bring orders to them.

That’s called a rebate. Exchanges pay brokers incentives to set prices because if they can’t attract the BBO part of the time, they don’t match trades, don’t capture market share, can’t generate valuable data to sell to brokers (Only IEX is eschewing rebates).

The problem for investors and companies is that trades motivated by rebates are like shill bids at art auctions (which by the way are prohibited). They set the best price for everybody else yet the shill bidder doesn’t want to own the painting – or the shares. That’s high-frequency trading. It’s 40% of market volume on average and can be 60%.

Bloomberg reported yesterday the SEC is planning to study access fees through a pilot trading program next year. We’re encouraged that it may include a group of securities with no rebates. But the initial framework begun in 2016 under Mary Jo White aimed to lower access fees, and the study right now contains those plans.

Why? Exchanges are already lowering them. How about setting a floor on access fees so exchanges can make a decent return matching trades and don’t have to engage in surreptitious incentive programs to compete? I got the idea from the Buttonwood Agreement and 200 years of history.

Say all exchanges charge baseline access fees. If this exchange or that wants to wrap more value around fees – better data or more technology or beer – they can charge more.

Whatever happens, we hope (and I asked Chairman Clayton by email) the SEC makes an issuer committee part of the process. Without your shares, public companies, there’s no market. We should have a say. That’s why we have to know how it works!

Mispricing

If the stock market reflects all information currently known, why are buyout deals nearly always done at a premium to market price?

“Because, Quast, deals involve proprietary pricing models that account for synergies.”

Sure. But I want you to think about prices. The Wall Street Journal recently reported that Blackrock cut fees on several exchange-traded funds (ETFs) to three cents per $100 of assets annually.

Low fees appeal. But how are they doing it?  After all, ETFs are notoriously high-turnover vehicles. The Investment Company Institute says conventional institutions sell about 42% of asset annually. Data from ETF Database showed ETF turnover of 2,200% annually, and leveraged ETFs using derivatives to achieve returns turning over a shocking 164 times more than underlying assets. At that rate, a $1 billion ETF could trade $164 billion of shares in a year. Tally your volume over the trailing year and divide by your average market-cap and it’s probably 1-3 times.

It’s an axiom of financial markets that churning assets consumes returns. So how can ETFs be low-cost vehicles? In June 2011, Financial Times of London writer Isabella Kiminska brilliantly observed that ETFs are built around what she termed “manufactured arbitrage.” If ETFs aren’t making money on fees it’s because they make it elsewhere.

In fact shares of ETFs represent something that exists elsewhere. Every day, ETF sponsors like Invesco and Blackrock give their brokerage agents called authorized participants (APs) a creation basket, a list of securities or other assets held by the ETF. The AP assembles this list for the ETF and receives in kind a bunch of paper – a chunk of ETF shares to sell. The AP may substitute cash for the creation basket too.

APs thus always know before everyone else whether demand is rising or falling. An AP could buy underlying securities (or borrow them) and supply them to the ETF, and then sell the ETF shares, and if the ETF is later discounted to the underlying securities, buy the ETF shares and redeem them to the ETF. The ETF industry in fact touts this continual arbitrage opportunity in ETFs as a key efficiency feature.

Actually, it explains why ETFs have low costs. There’s a lot of money in trading paper back and forth while not having to compete with anybody else.  ETFs and APs are a closed market that collectively is always a step ahead.

High-frequency traders (HFT) also claim to offer efficacy through frenzy.  Modern Markets Initiative, the HFT industry lobbying group, says HFT fuels “market efficiency” because automated markets reduce costs, enhance access and increase competition. It defies logic to propose you can reduce costs by doing more of something (politicians often make this claim, which future financial outcomes refute).

“Market efficiency” is a euphemism for arbitrage. We’ve been led to believe that because arbitrage occurs where pricing gaps form, created arbitrage will eliminate gaps. No, what goes away are real prices.

There’s yet a third instance of this pricing contradiction amid the market’s core building blocks. Reg NMS capped the fee for buying shares at $0.30 yet all three big exchanges pay sellers more than that. The NYSE pays its best trading customers about $0.34 per hundred traded shares, the Nasdaq about the same. BATS Group pays top customers in thinly traded stocks $0.45 per hundred shares to sell while charging just $0.25 per hundred to buy.  All three will pay extra to traders active in both stocks and derivatives, the latter called “Tape B” securities denoting the facility for most derivatives trades.

Why are they paying more than they charge? Arbitrage, here between the trades and the value of data. By paying traders to set prices, data become more valuable. All three sell feeds and technology to brokers and traders for sums ranging from $5,000 monthly for a cabinet in a collocation facility to $100,000 monthly for an enterprise data feed.

What drives most of the volume in markets? ETFs are behind disproportionate amounts. HFT gets paid to set prices.  And APs – the big prime brokers like Goldman Sachs and Morgan Stanley – drive half the market volume. A key motivation across the three is profiting on spreads.

These gaps aren’t occurring through information asymmetry or market inefficiencies but are manufactured through the form ETFs take as derivatives and through the fee-structure and function of the National Market System.

No wonder there’s a premium on go-private deals.  They cut out the middle men arbitraging away real prices. And no wonder it’s so difficult to match the market to reality. It’s deliberately and mechanically manufacturing prices. That’s apparent when one understands ETFs, HFT and exchange market-access fees.