Tagged: Rebates

Piloting Fees

What do these pension funds below have in common?

All (over $1.3 trillion of assets), according to Pensions & Investments, periodical for retirement plans, endorse the SEC’s Fee Pilot program on stock-trading in US equities.

The California State Teachers’ Retirement System
The California Public Employees Retirement System (CalPERS)
The Ontario Teachers Pension Plan (Canada)
The New York City Retirement Systems
The State of Wisconsin Investment Board
The Alberta Investment Management Corp. (Canada)
The Healthcare of Ontario Pension Plan (Canada)
The Alaska Permanent Fund Corp.
The Arizona State Retirement System
The San Francisco City & County Employees’ Retirement System
The Wyoming Retirement System
The San Diego City Employees’ Retirement System

In case you missed the news, we’ll explain the study in a moment. It will affect how stocks trade and could reverse what we believe are flaws in the structure of the US stock market impeding capital formation. But first, we perused comment letters from other supportive investors and found:

Capital Group (parent of American Funds) $1.7 trillion
Wellington Management, $1 trillion
State Street Global Advisors, $2.7 trillion (but State Street wants Exchange Traded Products, ETPs, its primary business, excluded)
Invesco, $970 billion
Fidelity Investments, $2.4 trillion
Vanguard, $5.1 trillion
Blackrock, $6.3 trillion (with the proviso that equal ETPs be clustered in the same test groups)
Assorted smaller investment advisors

By contrast, big exchange operators and a collection of trading intermediaries are either opposed to the study or to eliminating trading incentives called rebates.  We’ll explain “rebates” in a bit.

That the views of investors and exchanges contrast starkly speaks volumes about how the market works today.  None of us wants to pick a fight with the NYSE or the Nasdaq. They’re pillars of the capital markets where we’re friends, colleagues and fellow constituents. And to be fair, it’s not their fault. They’re trying to compete under rules created by the SEC. But once upon a time exchanges matched investors and issuers.

Let’s survey the study. The program aims to assess the impact of trading fees, costs for buying and selling shares, and rebates, or payments for buying or selling, on how trading in stocks behaves.  There’s widespread belief fees distort how stock orders are handled.

The market today is an interconnected data network of 13 stock exchanges (four and soon five by the NYSE, three from the Nasdaq, and four from CBOE, plus new entrant IEX, the only one paying no trading rebates), and 32 Alternative Trading Systems (says Finra).

The bedrock of Regulation National Market System governing this market is that all trades in any individual stock must occur at a single best price:  The National Best Bid to buy, or Offer to sell – the NBBO.  Since exchanges cannot give preference and must share prices and customers, how to attract orders to a market?  Pay traders.

All three big exchange groups pay traders to set the best Bid to buy at one platform and the best Offer to sell at another, so trades will flow to them (between the NBBO).  Then they sell feeds with this price-setting data to brokers, which must by rule buy it to prove to customers they’re giving “best execution.” High-volume traders buy it too, to inform smart order routers.  Exchanges also sell technology services to speed interaction.

It’s a huge business, this data and services segment.  Under Reg NMS, the number of public companies has fallen by 50% while the exchanges have become massive multibillion-dollar organizations.  No wonder they like the status quo.

The vast majority of letters favoring the study point to how incentive payments from exchanges that attract order flow to a market may mean investors overpay.

One example: Linda Giordano and Jeff Alexander at BabelFish Analytics are two of the smartest market structure people I know. They deal in “execution quality,” the overall cost to investors to buy and sell stocks. Read their letter. It explains how trading incentives increase costs.

Our concern is that incentives foster false prices. When exchanges pay traders not wanting to own shares to set prices, the prices do not reflect supply and demand. What’s more, the continuous changing of prices to profit on differences is arbitrage. The stock market is riven with it thanks to incentives and rules.

The more arbitrage, the harder to buy and sell for big investors. Arbitrage is the exact opposite motivation from investment. Why would we want a market full of it?

The three constituents opposing eliminating trading payments are the parties selling data, and the two principal arbitrage forces in the market:  High-frequency traders, and ETFs.

What should matter to public companies is if the stock market is a good place for the kind of money you spend your time targeting and informing. Look at the list above. We’ve written for 12 years now about how the market has evolved from a place for risk-taking capital to find innovative companies, to one best suited to fast machines with short horizons and the intermediaries selling data and services for navigating it.

Today, less than 13% of trading volume comes from money that commits for years to your investment thesis and strategy. All the rest is something else ranging from machines speculating on ticks, to passive money tracking benchmarks, to pairing tactics involving derivatives.

So public companies, if your exchange urges you for the sake of market integrity to oppose the study, ask them why $22 trillion of investment assets favor it? When will public companies and investors take back their own market? The SEC is offering that opportunity via this study.

Are there risks? Yes. The market has become utterly dependent for prices on arbitrage. But to persist with a hollow market where supply and demand are distorted because we fear the consequences of change is the coward’s path.

Mercenary Prices

Florida reminded us of high-speed traders.  I’ll explain.

An energized audience and the best attendance since 2012 marked NIRI National, the investor-relations annual confab held last week, this year in Orlando.

We spent the whole conference in the spacious and biggest-ever ModernIR booth right at the gateway and in late-night revelry with friends, clients and colleagues, and I don’t think we slept more than five hours any night.  Good thing it didn’t last longer or we might have expired.

I can’t speak to content because we had no exposure. But asking people coming through the exhibit hall what moved them, we heard about IEX CEO Brad Katsuyama’s general session on the state of markets (we said hi to Brad, who was arriving in from New York about 1am as we were wrapping for the night and heading to bed).

“He said the exchanges are paying $2.7 billion to traders.”

That what folks were reporting to us.

You remember how this works, longtime readers?  The big listing duopoly doled out $500 million in incentives to traders in the most recent quarter.  That is, exchanges paid others to trade on their platforms (the rest came from BATS Global, now part of CBOE).

Both exchanges combined earned about $180 million in fees from companies to list shares. Data and services generated a combined $750 million for the two.

There’s a relationship among all three items – incentives, listing fees, data revenues.  Companies pay to list shares at an exchange. The exchange in turn pays traders to set prices for those shares. By paying traders for prices, exchanges generate price-setting data that brokers and market operators must buy to comply with rules that require they give customers best prices.

I’m not ripping on exchanges. They’re forced by rules to share customers and prices with competitors. The market is an interlinked data network. No one owns the customer, be it a trader, investor or public company. Exchanges found ways to make money out there.

But if exchanges are paying for prices, how often have you supposed incorrectly that stocks are up or down because investors are buying or selling?

At art auctions you have to prove you’ve got the wherewithal to buy the painting before you can make a bid. Nobody wants the auction house paying a bunch of anonymous shill bidders to run prices up and inflate commissions.

And you public companies, if the majority of your volume trades somewhere else because the law says exchanges have to share prices and customers, how come you don’t have to pay fees to any other exchange?  Listing fees have increased since exchanges hosted 100% of your trading.  Shouldn’t they decrease?

Investors and companies alike should know how much volume is shill bidding and what part is real (some of it is about you, much is quant).  We track that every day, by the way.

The shill bidders aren’t just noise, even if they’re paid to set prices. They hate risk, these machine traders.  They don’t like to lose money so they analyze data with fine machine-toothed combs.  They look for changes in the way money responds to their fake bids and offers meant not to own things but to get fish to take a swipe at a flicked financial fly.

Take tech stocks.  We warned beginning June 5 of waning passive investment particularly in tech. The thing that precedes falling prices is slipping demand and nobody knows it faster than Fast Traders.  Quick as spinning zeroes and ones they shift from long to short and a whole sector gives up 5%, as tech did.

Our theme at NIRI National this year was your plan for a market dominated by passive investment.  Sometime soon, IR has got to stop thinking everything is rational if billions of dollars are paid simply to create valuable data.

We’ve got to start telling CEOs and CFOs and boards.  What to do about it? First you have to understand what’s going on. And the buzz on the floor at NIRI was that traders are getting paid to set prices. Can mercenary prices be trusted?

Take and Make

What if exchanges stopped paying fast traders to set prices? Oh, you didn’t know? Read on.

Off Salt Island in the British Virgins is the wreck of the HMS Rhone, a steamer that sank in an 1867 hurricane.  Even if you’re a snorkeler like me rather than a diver, in the clear BVI water you can see the ribs, the giant drive shaft, the shadowy hulk of a first-rate vessel for its day, 70 feet below the surface.  A storm surprised the Rhone, and after losing an anchor in the channel trying to ride out the squall, the captain ran for open water, unwittingly slamming into the teeth of the tempest.

What’s a 19th century Caribbean wreck got to do with high-frequency trading?  What seems the right thing to do can bring on what you’re trying to avoid by doing it in the first place.

On July 15, Senator Carl Levin called on the Securities and Exchange Commission to end the “maker-taker” fee structure under which exchanges pay traders to sell shares.  I’ve long opposed maker-taker, high-frequency trading and Regulation National Market System.

We have Reg NMS thanks to Congress.  In 1975, that body set in motion today’s HFT flap by inserting Section 11A, the National Market System amendments, into the Securities Act of 1934, and instead of a “free market system,” we had a “national market system.” What a difference one word made.

The legislation mandated a unified electronic tape for stock prices. The NYSE claimed the law took its private property – the data – without due process.  Regulators responded with concessions on how exchanges would set prices for trading. The result: The Consolidated Tape Association (CTA).

Today, the CTA is comprised of the registered US stock exchanges.  Its rules governing quoting and trading determine how exchanges divide roughly $500 million in revenue generated through data that powers stock tickers from Yahoo! Finance to  E*Trade.  If an exchange quotes stocks at the best national bid or offer 50% of the time, and matches 25% of the trades, it gets the lion’s share of data revenue for those stocks. And the more price-setting activity at an exchange, the more valuable their proprietary data products and technology services become. Data has value if it helps traders make pricing decisions.

Here’s where history meets HFT. Reg NMS requires trades to meet at the best price. Exchanges have no shares because they’re not owned by brokers with books of business as in the past. They pay traders to bring shares and trades that create the best prices.  In 2013, NASDAQ OMX paid $1 billion in rebates to generate $385 million of net income.  Subtract revenue from information services and technology solutions ($890 million in 2013, built on pricing data) and NASDAQ OMX loses money.  Prices matter.  NYSE owner Intercontinental Exchange (ICE) opposes maker-taker presumably because it made $550 million in profit without the NYSE in 2012, and half that adding the NYSE in 2013. For a derivatives firm, equities are a tail to wag the dog. (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…)

Among the eight panelists pondering how to forestall another Flash Crash, my favorite quote comes from Columbia professor and Nobel winner in Economic Sciences Joseph Stiglitz, who said in a 2008 paper: “Dollars are a depreciating asset.”

Potent statement. I invite you to consider its ramifications some other time, however. Let’s discuss what the Flash Crash Panel’s recommendations mean to the IR chair. They will affect how your stock trades.

We read all fourteen ideas. They range from charging traders for excessively posting orders and cancelling them, to setting limits on the permitted up/down movement of stocks and imposing circuit breakers for all securities save the most thinly traded. The panel clearly aimed at addressing investor uncertainty through controlling outcomes. If stocks are constrained to ranges, and algorithms to supervision, incentives are adjusted to encourage this, and fees imposed to stop that, the net result will be less uncertainty, the panelists hope.

The net result will be a market suited only to passive index money. If that’s what you want then you’ll be happy. If you want vital markets, where investors can differentiate your shares from other stocks, then a market built around rigid conformity is not for you. (more…)

The World Rocks and Markets Roll

Memo on a 70-point swing: Saturday we hiked the red rocks at the Denver Front Range’s Roxborough Park. It was 62 degrees Fahrenheit. This morning it was ten below zero.

Last Friday I was in Dallas (seventy-five degrees warm) for a trading panel discussion at the NIRI Dallas-Fort Worth chapter. Also Friday, the Market Structure Map from last week on artificial liquidity ran courtesy of Joe Saluzzi at the Themis Trading blog, and at Welling@Weeden, Kate Welling’s respected letter at Weeden & Co. (many thanks to both generous hosts). Today against a rocking backdrop of geopolitical unrest, rising global inflation, commodity uncertainty and cold winter weather, US equities are rolling.

Talk about wild temperature swings. Higher prices are nice. We loved them in home values too five years ago. There is no better way to be cool in the IR chair than riding a hot stock. And most times, your executives think your share price is undervalued.

But don’t you wonder, just a teensy bit, how come the prospect of the Suez Canal disappearing into a dark pool isn’t mildly sobering? We had four clients up 5-7% today, five down a little, and the vast bulk up equal or better than the market. Really? (more…)