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Buy-side sees value in SEC access-fee pilot, but some concerns remain

Doug Clark thinks the pilot will be good for long-term investors but will negatively effect exchange operators and others.

While a number of buy-side traders said they're generally satisfied with the Securities and Exchange Commission's proposal to create a transaction-fee pilot program, there are some omissions that have them concerned.

The SEC's proposal, presented March 14, calls for a two-year pilot program that, once approved and implemented, would study the effect of maker-taker — a process in which brokers receive rebates for providing liquidity to certain trading venues — on equity trade execution. The proposal now goes to a 60-day comment period before the agency votes on final approval.

Critics of the current maker-taker practice say the rebates spur broker-dealers to find trading venues based on revenue, rather than on best execution for clients.

The transaction-fee pilot would have three test groups for providing or removing liquidity: one at a 15-cent trade-fee cap per 100 shares; one with a 5-cent cap per 100 shares; and one with a ban on rebates. The last group, however, would retain the existing 30-cent-per-100-shares cap, but only on fees for marketable orders — those whose buy limit price is at or above the current market price, or ask, or sell limit is below the current price, or bid. A control group would be added with no cap on rebates.

All trades would be executed on public exchanges. The pilot does not include test groups using off-exchange venues such as dark pools or incorporating the existing trade-at rule, which requires brokerages to route trades to public exchanges unless they can execute them at a better price elsewhere.

"We are somewhat surprised to see that there is no trade-at inclusion and that off-exchange trading, including payment for order flow arrangements, was excluded, as some of the exchanges, particularly the (New York Stock Exchange), have been advocating to include these as part of a grand bargain on lowering access fees," said Doug Clark, managing director and head of market structure for the Americas at brokerage and financial services firm Investment Technology Group Inc., New York. Still, Mr. Clark said, "In general, we think the pilot will be good for long-term investors, but will likely have a negative impact on exchange operators and those liquidity providers feeding off the rebates."

Joseph Saluzzi, partner, co-founder and co-head of equity trading at agency brokerage Themis Trading LLC, Chatham, N.J., said not including trade-at was an effort by the SEC to satisfy exchange operators — the NYSE as well as Nasdaq Inc. and Cboe Global Markets Inc.

"People are getting pilot fatigue," Mr. Saluzzi said, referring to the proposed fee pilot and the ongoing tick-size pilot, which is slated to conclude in October, to improve liquidity in small-cap stocks. That pilot includes a trade-at provision. "Exchanges probably had a problem with that," Mr. Saluzzi said. "I think it was the right move by the SEC not to include that."

However, Mr. Saluzzi said including off-exchange venues in the fee pilot could be suggested during the 60-day comment period. "Maybe they'll do something going further to figure that out. (Including off-exchange trading) would be the next step."

Mehmet Kinak, vice president and head of global equity market structure and electronic trading at T. Rowe Price Group Inc., Baltimore, said that not including a trade-at group or off-exchange venues "is consistent with" the recommendations made by the SEC's Equity Market Structure Advisory Committee in April 2016. Mr. Kinak was a member of the committee, which was disbanded in January. He agreed the trade-at provision "doesn't need to be included again in the transaction-fee pilot."

The SEC's proposal "is much more in line with what supporters of an access-fee pilot would recommend," Mr. Kinak said. But he warned the SEC's proposal only reduces the lowest access fee charged by exchanges to 5 cents per 100 shares traded, "allowing enough variability for exchanges to price across their multiple platforms and may not deter or address the conflict of interest in broker routing."

The advisory committee had recommended pilot fees and rebates per 100 shares be capped for separate stock groups at 20 cents, 10 cents and 2 cents.

"The proposal put forth by the SEC included a lot of compromises which were necessary to continue to move the idea of an access-fee pilot forward," Mr. Kinak said, adding he was "very pleased to see a zero-rebate bucket," which was not part of the committee's recommendation.

The inclusion of the zero-rebate group was a good move, said Themis' Mr. Saluzzi. "We think that's where we'll really be able to judge" the impact on rebates, he said. "(The SEC) anticipated that the exchanges might get a little cute with finding another way to kind of get a rebate. This is the SEC thinking ahead. What they put together is a very good plan."

ITG's Mr. Clark agreed with the overall assessment of the pilot program: "We expect the scope of the pilot, all listed stocks, and the length — two years with a one-year sunset provision — will provide detailed and accurate insights into how various pricing arrangements impact equity market structure, and we applaud the SEC for taking such a broad approach."

Among the exchanges, Cboe Global Markets, Chicago, which operates four equities exchanges, warned of the impact the pilot could have on trading costs. "Around the world, the U.S. equity market is known for its depth and liquidity, and for consistently rewarding investors with ever-decreasing trading costs," said a Cboe spokeswoman. "Anything that impacts those attributes ... has to be managed carefully against that very high bar of success."

In a joint Oct. 13 letter to SEC Chairman Jay Clayton, Cboe, NYSE and Nasdaq said the "arbitrary introduction of an ill-defined access-fee pilot" imposes price controls on a competitive market. The exchanges called for a more broader review of the SEC's Regulation National Market System, which governs overall equity trading in the U.S., and said omitting off-exchange venues from the pilot would limit the exchanges' ability to compete for trades.

Spokesmen for NYSE and Nasdaq said their exchanges had no comment.