Money managers want the Securities and Exchange Commission to examine maker-taker rebates — to limit or eliminate them for all stock trades — claiming that the rebates spur broker-dealers to find trading venues based on revenue, rather than on best execution for clients.
And while maker-taker — a process in which brokers are given rebates for providing liquidity to certain trading venues — isn't being seen as the direct cause of the July 8 outage at the New York Stock Exchange, sources said the complexity of the pricing system has added to equity market fragmentation. That's because brokers will search a variety of venues to find rebates, adding another layer to an already cumbersome trading process, they said.
“The fact that the markets are as fragmented as they are, one could argue that fragmentation might have actually played a part in (the NYSE) problem,” said Ryan Larson, head of equity trading, U.S., at RBC Global Asset Management (U.S.) Inc., Chicago. “With the multiple order types that exist in today's environment, the constant need for speed, abnormally excessive messaging traffic and the demand on exchanges to constantly upgrade and update their systems to keep up, it's no surprise that software glitches occur and will continue to occur. In my opinion, the next step following (the outage) should be the need to finally address maker-taker and the complexities that pricing model imposes on the current environment.”
Such concerns are why managers, along with many agency broker-dealers, want the SEC to conduct a pilot program on maker- taker rebates that could contain multiple options — a control group with current maker-taker rebates, one with limits on rebates and one that bans maker-taker on selected stocks.
Other ways to spur the SEC to address changes in the maker-taker system, traders and brokers said, include recommendations from the SEC's Equity Market Structure Advisory Committee, founded this year and charged with discussing a variety of broad market-structure issues, and legislation, such as a bill introduced in March by U.S. Rep. Stephen Lynch, D-Mass., to require the SEC to conduct a maker-taker pilot. (That bill has languished in committee and industry observers said there's little appetite in a Republican-led House to pass it.)
Along with conflict-of-interest issues with rebates, other concerns like increased transaction costs and lack of transparency have “added to the complexity of today's market structure,” said Mr. Larson. “Whether it's SEC mandated, or better yet, driven from market participants themselves, I think it's time to finally address the elephant in the room and start thinking about possible alternatives to the maker-taker model. ... It's not just the buy side that has been calling for a pilot on maker-taker. It's the sell side, some of the exchanges, Congress, even members of the (SEC) as well. When you see that diverse of a group calling for change, I think it suggests something very important — whether maker-taker is the right approach. This could be one of the most impactful tests ever taken up in market structure.”
Need to align interests
Andrew M. Brooks, Baltimore-based vice president and head of U.S. equity trading at T. Rowe Price Associates (TROW) Inc. (TROW), said there's no opposition to brokers receiving revenue. “If you bring value to the market, you deserve a fair return,” Mr. Brooks said. “What's needed is aligning the interests of all market participants.”
Although many market participants are against maker-taker, it still exists because it's perceived by many as a means of finding liquidity in what's become an illiquid market for all but the select few large-cap stocks. (The SEC is currently running a two-year tick-size pilot program to address illiquidity in small caps.)
“The whole point of maker-taker is to incentivize display of liquidity in lit markets,” said Henry Yegerman, director of trading analytics and research at financial data provider Markit Group Ltd., New York. “Market participants who place trades that rest passively in a venue, and so add liquidity, get a rebate. Investors who aggressively cross the spread to access that liquidity pay a fee to do so.” Institutional investors that are looking to buy or sell large blocks of stocks “are frequently takers of liquidity,” he said.
But at least one market participant disagrees that maker-taker is necessary. Joseph Saluzzi, partner, co-founder and co-head of equity trading of Themis Trading LLC, a Chatham Township, N.J.-based agency broker for institutional investors said the link between liquidity and maker-taker doesn't exist. What maker-taker does increase, Mr. Saluzzi said, is volume. “Liquidity and volume are two different things,” Mr. Saluzzi said. “Maker-taker creates volume, and a lot of that is artificial.”
Mr. Saluzzi said liquidity access is not helped through maker-taker, but by changes in a fragmented market structure that would reduce the number of trading venues. “Liquidity is not helped by rebates, but by less fragmentation,” Mr. Saluzzi said. “Maker-taker is the linchpin of the problems with the market. It's a relic of a system that was around 15 years ago.”
Eugene A. Noser Jr., co-founder of Abel/Noser Corp., a New York-based agency broker for asset owners, said that all market participants should be able to make money through trading, but that with maker-taker, some brokers get added benefits that other participants can't. “Market makers have to be able to make money, (but) because spreads are so narrow, that's become a problem” Mr. Noser said, which has ramped up brokers' search for rebates. “Who's causing bad behavior are those who only put up orders to get rebates,” he said. “They're creating volumes that aren't real. You get rid of rebates, you get rid of them. You cut down on spoofing and you cut down on quote stuffing.”
The New York Stock Exchange came out against maker-taker rebates in testimony by exchange executives in 2014, while Nasdaq Global Markets is running a pricing test program that lowers rebate pricing for select stocks to gauge the effects on liquidity. In two reports this year on the test, Nasdaq has said the lower rebates have had a negative effect on liquidity.
Executives at BATS Global Markets Inc. don't support an outright maker-taker ban and think the rebate paid to liquidity providers matters, “particularly with less liquid securities,” said Eric Swanson, general counsel at BATS, Kansas City, Mo.
A Canadian test
Markit's Mr. Yegerman said Canada could provide an example of what an SEC test could look like. TSX Group, operator of the Toronto Stock Exchange, on June 1 began a test that reduced the maker-taker rebates in that market. In June 2014, the Canadian regulators were looking at ending maker-taker pricing altogether.
“What they're doing in Canada can serve as kind of a test case for the U.S.,” Mr. Yegerman said. “In a short period of time we should have an idea of what could potentially happen if you limit the use or reduce maker-taker fees.”
Officials at the SEC did not return calls seeking information on whether it would conduct a maker-taker test. However, SEC Commissioner Luis Aguilar in April 2014 said the agency should look at maker-taker as part of its overall review of equity market structure.
T. Rowe's Mr. Brooks said maker-taker is an issue that institutional asset owners generally leave to their money managers. But if the issue surrounding rebates is tied in with liquidity, it's important to asset owners, said William Atwood, executive director of the $19.8 billion Illinois State Board of Investment, Chicago.
“What I really care about is sufficient liquidity in the system,” said Mr. Atwood “Is maker-taker a necessity to drive liquidity? I don't know the answer to that ... I think there's a concern that it's all transparent. As long as traders and managers focus on price and execution, building in costs in order to maintain liquidity, if maker-taker lets you do that, then fine; if not, then do something else.” n
This article originally appeared in the July 13, 2015 print issue as, "Managers push SEC for limits on brokers' maker-taker rebates".