Tagged: Rebate Trading

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!

Setting Prices

Do you remember that movie, The Island?  The people who every day hope they’re selected to go to a tropical paradise are unwitting machinery for others.

I won’t give it away in case you’ve not seen Scarlett Johansson and Ewan McGregor tearing through the sky on some futuristic motorcycle. Things are not what they at first seem. That’s the point.

Which leads us to Nasdaq OMX PSX.  On August 1, the PSX becomes what it calls “a Price Setter Pro Rata algorithm for all symbols, pending SEC approval.” The PSX once was the Pacific Stock Exchange. Now it’s one of the Nasdaq’s three stock markets.

If it’s an exchange, why do they call it an algorithm? Because it’s less a marketplace than a mathematical calculation designed to do something: Set prices. It guarantees traders 40% of an order so long as size meets requisites.

In its marketing materials, the Nasdaq says the PSX is “a Reg NMS protected quote and runs on proven INET technology.” A quote? A price. Under Reg NMS, protected quotes must be automated and cannot be ignored by the market. So the PSX is a price.

INET was a trading system created by the dark-pool Instinet that merged in 2002 with Island, another electronic communications network, or “ECN.” ECNs slaughtered exchanges in the 90s, taking perhaps 65% of all trading at the peak before exchanges bought them and in effect became ECNs. Nasdaq acquired INET in 2005.

Now stay with me here. This story relates directly to you, in the IR chair. There’s a trading firm called Chimera Securities. We see it in about 75% of our Nasdaq client base. It’s a proprietary trader – no customer accounts. It trades equities and options. It provides a platform for hundreds of professional day-traders to execute diverse speculative tactics, and it runs automated strategies to utilize liquidity its traders hold. It’s a member of the Nasdaq OMX PSX, and the Nasdaq OMX PHLX, the latter the Nasdaq’s options platform. Chimera belongs only to these two markets. (more…)

Flash Boys

I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.

Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”

Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.

If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.

The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.

Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.

Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.

These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules. (more…)

The Dark Exchange

I’m reminded of a joke (groans).

A man is sent to prison. As he settles into his captive routine he’s struck by a midafternoon affair among his jailed fellows. One would shout out, “Number 4!” The others would laugh.

His cellmate, seeing the newbie’s consternation, explained: “We’ve been here so long we’ve numbered the jokes instead of saying the whole thing. Here, you try. Number 7 is a really funny one.”

“What, just shout it?”

“Yeah, exactly.”

“Number 7!”

Silence.

The cellmate shook his head. He said, “Some people just can’t tell a joke.”

Speaking of numbered jokes, the NYSE filed with regulators to offer new order types – regulated ways to trade stocks – designed to attract large institutional orders now flowing to “dark pools,” or marketplaces operated by brokers where prices aren’t displayed. The exchange has long battled rules in markets that promote trading in dark pools, arguing that these shadowy elements of the national market system inhibit price-discovery.

Let’s translate to English. The NYSE is a big stock supermarket with aisles carrying the products your equity shopper needs, where prices and amounts for sale are clearly displayed. Across the parking lot there’s an unmarked warehouse, pitch black inside, with doors at both ends.

You can duck into the supermarket and check prices and supplies for particular products, and then hurry over to the warehouse and run through it holding out your hands. You might emerge with the products you wanted at prices matching those in the supermarket. (more…)

Knight Time

Some were forced to do it themselves.

In the wake of Knight Capital’s technology glitch – if you missed it, a linchpin in trading markets was nearly undone Aug 1 by faulty trading software – some brokers who normally route order flow to Knight for handling had to execute their own trades.

They’re not as good at it. No question. But a curious thing happened. We observed a measurable increase in share of market for rational money. More volume acted like rational investment the days following.

Why? How? Today, money often puts compliance before investment considerations. Say you’re a mid-tier broker-dealer whose client is a small Midwest municipal pension fund. The fund puts a modest percentage of resources into a trading portfolio and directs trades to you because your firm’s president golfs Fridays with the mayor.

Before we continue, breaking news: I’m in New Orleans next week to sit down with JOE SALUZZI, co-author of Broken Markets, for a candid chat on what ails markets today. I’m also moderating a wild brawl of a panel discussion on the hot topics in IR today. If you’re not in the Big Easy next week, well…you’re not where you should be.

Back to our story. Market rules require that you as a broker execute trades in something similar to the amount of time that Morgan Stanley does, which is hard to do without more risk to your firm’s capital base (meaning your money takes the other side of trades if nobody else is there). Face it. A family brokerage in Bloomington, IL, isn’t going to host its servers right next to the Nasdaq’s in Trumbull, CT, like Morgan Stanley. (more…)

Bending Like Beck

Do you hate day traders?

Reading the 30-page Waiver and Consent letter from Peter Beck, who once ran now-defunct day-trading firm Swift Trade, it seems FINRA must.

Maybe you do too. But there’s a lesson in the story here, IR folks.

If you missed it, Beck’s woes got page-one billing from the keyboard of Scott Patterson at the Wall Street Journal yesterday. Beck ran a loose global day-trading federation last decade that at peak hosted some 4,000 traders outside the United States funneling orders through Beck’s execution broker Biremis Securities in Toronto.

The allegations are a compendium on failed oversight. We counted 35 instances of the words “appropriate,” “proper,” “improper” and “improperly” in the document signed by Beck and his legal counsel. It effectively bans Beck from US securities markets (although Beck operated outside the US so the ban seems hollow).

Behind bolded subheadings, the letter says primarily that Beck failed to supervise staff, didn’t keep good records and didn’t comply with standards. What gets attention in the Wall Street Journal is a practice called “layering,” in which traders place a bunch of orders at various price points, say, to buy shares in one place, and then simultaneously enter opposing orders elsewhere, and then cancel most orders as soon as other participants react. The aim is a quick profit at minimal risk. (more…)

When Investors Buy and Sell

When investors buy and sell shares, what happens?

The logical answer is “stocks go up and down.” Let’s get more specific. Among the 20 largest asset managers at the end of 2009, ten were bank-owned, says consulting firm Towers Watson. The five largest – Blackrock, State Street, Allianz, Fidelity and Vanguard – are independents that pass the preponderance of their buying and selling through the biggest sellside firms on passive equity and ETF trading programs.

The banks behind ten of the twenty largest asset managers include BNP Paribas, Deutsche Bank, JP Morgan, BNY Mellon, Credit Agricole, UBS, Goldman Sachs, HSBC and Bank of America.

The top ten futures brokers for 2009 were Newedge (Societe General/Credit Agricole joint venture), Goldman Sachs, JP Morgan, Deutsche Bank, Citigroup, UBS, BofA, MF Global, Morgan Stanley and Barclays. (more…)

We’re late this week due to celebrations around the anniversary of the rebellion from the Crown. We played croquet, appropriately and cheekily British we thought (no offense to our good friends and former overlords across the pond). Croquet has actual rules we learned.

Sunday, Karen and I loaded the bikes and set out with good friend Jeffrey to conquer the passage between two of Colorado’s tall “fourteeners” named Princeton and Harvard. We rode from the Arkansas Valley floor at 8,000 feet up Cottonwood Pass (which sounds like “cotton whupass”) from Buena Vista to the summit at 12,126 feet and a stunning view of the fruited plain.

Choosing a route from point A to point B had me thinking about stock trades (you do this long enough, that’ll happen to you too). Stock trades must have routes. Sometimes it happens automatically. Whether orders for shares in your stock meet their matches internally at Barclays or by dint of timing, routing, pricing and chance at Susquehanna’s dark pool, RiverCross, often is a matter of routing. Even online brokers afford ways to route trades now. (more…)

On the NYSE and Knight Floors

Denver is an icebox, so we went east to New York to warm up. Lovely here, the tree glittering at Rockefeller Center and the snowflakes magically materializing to music on the Saks & Co. façade. Festive!

Carmen Barone and the Barclays team graciously hosted me yesterday on the NYSE trading floor, and in the afternoon Marge Wywras at Knight Capital Group turned me loose with the traders on the Knight floor in Jersey City. That’s darned near a perfect business day to me. (more…)