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Regulation

Funds, managers give big thumbs-up to trading fee rebate pilot study

Edward Tilly, CEO of CBOE Global Markets Inc., said the pilot proposal ‘is a solution in search of a problem.’

Pension funds and money managers have come out strongly in favor of the Securities and Exchange Commission's proposed transaction fee pilot to study the effects of maker-taker rebates on equity trade execution, based on a review of comment letters submitted on the proposal.

The $352.8 billion California Public Employees' Retirement System, Sacramento, and the C$189.5 billion ($145.8 billion) Ontario Teachers' Pension Plan, Toronto, backed the pilot proposal in a May 25 letter endorsed by U.S. and Canadian public pension funds and asset owners. In total, the group oversees $1.31 trillion in assets.

The letter said the pension plans have "a deep interest in market structure reform that enhances our ability to pay pensions and invest plan assets on behalf of our members and beneficiaries."

Among the plans that endorsed the letter were the $224.8 billion California State Teachers' Retirement System, West Sacramento; the $194 billion New York City Retirement Systems, on behalf of the city's five public pension plans; the $117 billion State of Wisconsin Investment Board, Madison; and the C$103.7 billion Alberta Investment Management Corp., Edmonton.

Among money managers who submitted comments, Vanguard Group Inc., Valley Forge, Pa., called the pilot an "appropriate next step to improve the robust U.S. equity markets for investors. In particular, we support the pilot's focus on whether transaction fees promote conflicts of interest by incentivizing trading designed to capitalize on capturing rebates and avoiding fees."

In March, the SEC approved a proposal for a pilot that would measure the impact of changes to maker-taker fees — rebates given by stock exchanges to brokers in exchange for moving trades to their venues — on order routing, execution and general market quality. Opponents of maker-taker fees claim the rebates spur brokers to choose exchanges that might not provide best execution for a given trade. Exchange operators have argued that there's no evidence that such fees have harmed the equity market.

If approved in its current form by the SEC, the pilot would have three test groups for providing or removing liquidity, with one group at a 15-cent trade fee per 100 shares, one with a 5-cent cap and one with a ban on rebates, though the last group would keep the existing 30-cent per 100-share cap on fees for removing liquidity. A control group would be added with no cap on rebates. The SEC is expected to vote later this year on whether to implement the two-year pilot.

The comment period on the proposal ended May 25, but Mehmet Kinak, vice president and head of global equity market structure and electronic trading at T. Rowe Price Group Inc., Baltimore, said T. Rowe Price met with SEC executives about the pilot and still plans on submitting a comment letter. Mr. Kinak served on the SEC's Equity Market Structure Advisory Committee, which recommended the fee pilot.

Pension fund executives contacted for this story would not comment beyond what was written in the letters. But John Ramsay, New York-based chief market policy officer at IEX Group Inc., which submitted a comment letter favoring the transaction fee pilot, said he thinks the funds "recognize that they and their beneficiaries are being harmed by the conflicts of the existing exchange fee system. ... The pension funds are the last fiduciaries standing between the markets and millions of plan beneficiaries, who deserve a market structure that puts their interests first."

Mr. Kinak of T. Rowe Price said maker-taker fees are "a common theme" among investors and asset owners who believe the equity market is overly complicated. "In the last 10 years, there's generally been cost compression in the markets across the board, except with maker-taker," Mr. Kinak said. "We need regulators' help in dealing with this, which is what the pilot would do."

OMERS Administration Corp., which oversees capital markets for the C$95 billion Ontario Municipal Employees' Retirement System, Toronto, "strongly endorsed" the SEC pilot, according to its comment letter. However, it asked the SEC to "clearly lay out the parameters and metrics to be studied by individual trading firms and the SEC."

"The SEC should explicitly detail the specific questions it wishes to address, detail the exact data needed to do that, outline how it will collect the relevant data to analyze and answer those questions, and then explain how the SEC, market participants, and researchers will be able to use that information to answer those key questions," the OMERS letter said.

Among the first money managers to file a letter in favor of the pilot was Southeastern Asset Management Inc., Memphis, Tenn., which has been outspoken in the past on trading-related issues. "The pilot will further the commission's long-held goal of increasing market-enhancing competition among exchanges, with a focus on execution quality and service, as opposed to paying the highest rebate," the letter said.

W. Douglas Schrank, principal and head of trading at Southeastern Asset and a co-signer to the letter, said in an email that the firm "felt obligated to speak up in support of the SEC on this issue and encouraged others to make their voices heard as well."

"With this well-designed proposal, the SEC has shown an intellectually honest desire to study the effects of exchange transaction fees on market quality," Mr. Schrank said. "By isolating the transaction fee variable, it will eventually be possible to study and correct other harmful aspects of market structure. If the SEC can remove needless complexity and minimize conflicts of interest without hurting the robustness of the U.S. markets, it would be an enormous success."

In its comment letter, BlackRock (BLK) Inc. (BLK), New York, supported the SEC proposal but disagreed with some who suggested that the pilot include the "trade-at" rule, which requires brokerages to route trades to public exchanges unless they can execute them at a better price elsewhere. The rule's inclusion, BlackRock said, "would overcomplicate the proposal and risk compromising the integrity of the pilot."

Separately, BlackRock, which had $1.752 trillion in its iShares exchange-traded products as of Dec. 31, and Vanguard, with $853.2 billion in ETF assets as of Dec. 31, both recommended that ETFs and other exchange-traded products be included in the pilot to provide, according to BlackRock, "a more inclusive analysis of rebates and fees across all segments" of National Market System stocks.

In opposition to the fee pilot, Edward Tilly, chairman and CEO of Cboe Global Markets, Chicago, said the pilot proposal "is a solution in search of a problem" and recommended instead "a holistic review" of Regulation National Market System, the SEC rule that governs equity trades.

"What is the problem the commission is trying to address?" Mr. Tilly asked in the letter. "At a minimum, that should be clearly articulated before implementing a significant market structure change across a sizable portion of the equities market. Other corners of the equities market landscape have drawn criticism from commenters, including how large investor orders are processed, how less-liquid stocks trade, and whether market fragmentation is adversely impacting investors. This proposal ignores those issues, despite the fact that virtually all aspects of equity market structure are intertwined."