Bats Global Markets Inc. plans to start a one-year program Dec. 17 to compete with the New York Stock Exchange by giving retail investors better prices.
The service will allow orders from individuals to get prices at least a tenth of a cent better than those available to mutual and hedge funds, brokers, and other firms, according to Chris Isaacson, chief operating officer at the third-largest U.S. stock market operator. Bats BYX Exchange, one of its two equity markets, is seeking more orders from individuals to compete with firms like Knight Capital Group Inc. and Citadel LLC that provide transactions to clients of retail brokers.
NYSE’s retail-liquidity program, which began in August, was the first by a stock exchange to segment orders and offer different prices based on the type of user. Chief executives of NYSE Euronext, Nasdaq OMX Group Inc. and Bats have said in congressional testimony, at conferences and on calls with analysts that their markets are hurt by restrictions on how they execute orders that don’t apply to brokers and off-exchange venues that trade within their own walls.
“The pilot is a good market structure innovation the Securities and Exchange Commission has allowed,” Isaacson said in a phone interview. “We think our program is well designed but won’t know the impact until we actually roll it out.” Isaacson declined to say how much Bats expects the program to boost its share of U.S. equities trading beyond its current 13 percent. “Our expectations are realistic,” he said.
Joe Ratterman, chief executive officer and president of Lenexa, Kansas-based Bats, said at a Baruch College conference in New York last month that while it would have been better for the SEC to raise the standards for dark pools, or private broker-run venues, in lieu of allowing exchanges to offer better prices only to some investors, taking a step toward making the rules more equitable was important.
The debate about whether it’s better to bring together more orders from a diverse set of traders on fewer venues or allow firms to tailor their executions and costs by trading in multiple venues has persisted for decades. Critics of the current regulatory structure of U.S. markets argue that 13 stock exchanges, several other public markets and more than 40 dark pools, more than half of which were created in the last seven years, has produced too much complexity.
“We’re last in the food chain,” Joe Mecane, head of U.S. equities at NYSE Euronext in New York, said at the Baruch event. Exchanges end up with orders that are called the “exhaust, everything that’s been picked over” by brokers and dark pools, he said. Winning SEC approval of its retail program took “two years of negotiating and fighting,” he said.
NYSE Euronext retail liquidity program has given users prices for 250 million shares that are an average of 1.4 cents better than the best buy or sell levels publicly available, according to information on the exchange’s website. The service averaged 5.7 million shares a day from Nov. 16 to Nov. 23, the company said. Almost 2,000 companies had better-priced orders available at the exchange for retail brokers, NYSE said.
About a third of U.S. equities trading, which averaged 6.5 billion shares a day this year, occurs away from exchanges, according to data compiled by Bloomberg and Bats. The “vast majority of marketable retail orders” are executed by over-the-counter market makers away from exchanges, the SEC said when it approved the Bats program. Retail price-improvement programs “should promote competition between exchanges and OTC market makers,” it said.
The SEC, which approved the Bats program on Nov. 27, gave the exchange an exemption for the trial from the so-called sub-penny rule, which bans exchanges from accepting and ranking orders for stocks more than $1 in increments of less than 1 cent. That rule was adopted in 2005.
Incoming orders from retail clients can trade against Bats orders submitted specifically for those users by firms certified to supply better-priced liquidity through the program. An order from an individual investor can get an execution against those price-improving orders, which are not displayed publicly, or from other hidden orders designed to trade with anyone at the midpoint of the national best bid or offer, or NBBO.
If the bid-offer spread is 1 cent, a midpoint order will give a retail investor a price that’s 0.5 cent better than what’s publicly available, compared with the minimum 0.1 cent through the program, Isaacson said. NYSE doesn’t have hidden orders priced at the midpoint of the NBBO.
“We allow retail orders to execute at multiple prices and they can interact with midpoint orders,” Isaacson said. He expects the amount of price improvement investors get per share on BYX to be superior to what they receive on NYSE, he said.
Bats said in an announcement today it will begin its program with securities that are the most heavily traded by individuals. It plans to expand to all exchange-listed products that are at least $1 and will offer two sets of pricing.
Nasdaq Stock Market is also planning a program to deliver better prices to retail customers. Price-improving orders could be submitted at a tenth of 1 cent better than the best available price or “implicitly priced” through the equivalent of an order pegged to the NBBO with what’s called an offset of $0.001, New York-based Nasdaq said in its Nov. 19 proposal to the SEC.
Better-priced orders intended for retail clients could be for fewer than 100 shares, known as a round lot, Nasdaq said. Orders from retail customers could trade with price-improving orders and other hidden trade requests at the exchange, as is the case in the Bats program. The exchange will allow retail orders to trade only with price-improving orders or also execute against other buy and sell requests at Nasdaq or on other venues, the proposal said.
“While the exchange believes that markets and price discovery optimally function through the interactions of diverse flow types, it also believes that growth in internalization has required differentiation of retail order flow from other order flow types,” Nasdaq told the SEC. Internalization refers to the execution of orders within a broker-dealer.
Nasdaq said earlier this year its effort would take the form of automated 1-second auctions for orders from individuals, according to Eric Noll, executive vice president for transaction services, who spoke at a conference in May. A written presentation said the auctions would be similar to those on U.S. options exchanges, in which market makers vie to win the investor’s order by providing the best price. Its November proposal opted for a different set of rules without auctions.
To spur volume Bats initially won’t earn trading fees. It will charge those providing price-improving orders for individual investors the same amount it rebates the brokers of those retail customers. Usually exchanges earn the difference between the fee and credit. While the biggest markets charge incoming orders and use those funds to pay liquidity providers, some exchanges reverse who pays and is paid to attract users with different trading and financial priorities.
Bats will start its program with 20 securities. Half, including Apple Inc., Citigroup Inc., Facebook Inc., the Direxion Daily Financial Bull 3X Shares, and the SPDR S&P 500 ETF Trust, will have rebates and fees of 25 cents per 100 shares. Five stocks and exchange-traded funds in this group have prices above $100.
The other set of 10 securities, including JPMorgan Chase & Co., Ford Motor Co. and Sirius XM Radio Inc., will have a fee and rebate of 10 cents per 100 shares. Six of these stocks trade for less than $10, making the fee a smaller percentage relative to the stock price. BYX’s current rebate for liquidity takers is 2 cents per 100 shares while it gets 2 cents or 3 cents from firms adding liquidity that’s publicly visible.
Direct Edge Holdings LLC has no immediate plans to introduce a price-improvement program specifically for retail traders, according to Brian Harkins, chief operating officer at the Jersey City, New Jersey-based equities exchange operator. The firm said Nov. 12 it would offer separate pricing to member firms acting on behalf of individual investors. That pricing will go into effect on Dec. 17, the day of Bats’s new program, Direct Edge said on Nov. 27.
“Right now, RLP has had modest success,” Harkins said of the NYSE’s program. “We don’t think retail brokers are clamoring for a price-improvement mechanism on equity exchanges. They’re getting that product from market makers, wholesalers and broker-dealers today. But we’re keeping an eye on how things change.”
Retail orders on EDGX Exchange that add liquidity will get a 32-cent credit per 100 shares instead of the 23-cent rebate most others receive, while everyone seeking executions against existing buy and sell requests will pay 30 cents per 100 shares or round lot, Direct Edge said in its announcement.
“We aim to recognize the fact that retail members and retail order flow has high value to an exchange,” Harkins said on Nov. 12 by phone. The exchange may build new products based on the retail-customer designation, he said. “We want to make EDGX a stand-out destination for retail members,” he said.
Exchanges may have a hard time categorizing investors and traders beyond the retail segment in an effort to compete with dark pools, Harkins said.
“The retail one is one the industry generally agrees on,” he said. “Categorizing others like professional traders and institutions is harder to do since a lot of firms represent a blend of that.”