December 6, 2017

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!

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