Trading Rebates Skew Markets, NYSE and Allies Tell SECDave Michaels
The New York Stock Exchange and a group of money managers are lobbying U.S. securities regulators to abolish the practice of paying rebates to large brokers to attract trades to stock exchanges and other trading platforms, according to three people familiar with the matter.
Jeff Sprecher, chief executive officer of NYSE owner IntercontinentalExchange Group Inc. and vocal critic of the rebate system known as “maker-taker,” was among a group of about 15 industry executives who met with members of the Securities and Exchange Commission earlier this month, said the people, who asked not to be named because the meetings were private. The group asked commissioners to conduct a pilot program to test whether stocks would trade differently without the incentives.
Other firms that attended the series of meetings with SEC commissioners on Feb. 6 included T. Rowe Price Group Inc., Royal Bank of Canada and IEX Group Inc., which operates a trading venue owned by institutional investors, the people said.
Any change to the maker-taker system could affect the profits and business models of stock exchanges, their competitors known as dark pools, and automated trading firms that reap the benefits of rebates, such as Citadel LLC, Goldman Sachs Group Inc. and Virtu Financial LLC.
It could also reduce the number of exchanges and other venues in the $22 trillion American equity market. The three biggest market operators -- ICE, Nasdaq OMX Group Inc. and Bats Global Markets Inc. -- collectively run 10 stock exchanges that handle about 60 percent of stock trading volume.
In remarks at a conference in Florida last week, Sprecher said that without maker-taker, NYSE might only need one stock exchange instead of three and predicted his rivals would also consolidate their venues.
“Mr. Sprecher is interested, just as we are, in challenging the maker-taker program,” said Andy Brooks, head of U.S. equities trading at T. Rowe Price, who declined to discuss the meetings. “There is a groundswell of people here saying maybe we have gone too far, maybe our aggressive pursuit of innovation and complexity has pushed us a little too far.”
The lobbying effort comes as SEC Chairman Mary Jo White is under growing pressure from lawmakers and business groups to revisit the rules that govern trading on modern stock markets. A House Financial Services subcommittee could discuss the issue during a hearing on equity-market rules next week.
White has said the agency is in the process of rethinking its assumptions about the way markets work, including the disparate rules that apply to exchanges and dark pools, which largely perform the same function.
The maker-taker system was pioneered in the late 1990s by electronic networks hoping to lure traders away from established exchanges by offering rebates. U.S. exchanges eventually adopted it in order to compete with the upstarts, who were drawing off trading volume.
Makers v. Takers
The maker-taker pricing standard is now the predominant way exchanges attract orders from brokers who have other options. Traders who stand ready to buy or sell shares as needed -- known as “market makers” -- are paid rebates by the exchange, while those on the other side of the transaction -- the “takers” -- pay a fee. Exchanges profit off the difference between those fees.
Proponents of the maker-taker system say it has lowered costs for investors and eased buying and selling of shares. Any move to prohibit it could attract opposition from brokers that operate competing venues including dark pools as well as institutional investors who worry trading costs will rise, said Larry Tabb, CEO of market-research firm Tabb Group LLC.
Critics of maker-taker say it creates a conflict of interest for brokers because it encourages them to send orders to maximize rebates instead of serving clients, Richard Steiner, RBC Capital Markets’ equities liaison for regulatory affairs, wrote in a comment letter to the SEC in November.
Tabb said that eliminating maker-taker could benefit NYSE, the Nasdaq Stock Exchange and others because they are currently losing trading volume to alternative venues such as dark pools, which charge lower transaction fees.
“Basically all the dark pools that don’t have a tremendous amount of liquidity probably will go away,” Tabb said in a telephone interview.
Brad Katsuyama, CEO of IEX, declined to comment on the meetings, as did ICE spokeswoman Kelly Loeffler, RBC spokeswoman Kait Conetta, and SEC spokesman John Nester.
Bloomberg LP, the parent of Bloomberg News, also owns Bloomberg Tradebook, which operates an alternative trading system registered with the SEC. Mark Murphy, a spokesman for Bloomberg LP, declined to comment on the maker-taker system.
One of the SEC commissioners who met with the Sprecher group, Kara M. Stein, recently called for considering proposals to alter the current system of pricing incentives. In a speech in New York earlier this month, Stein asked whether the rebates “incentivize or penalize” investors.
“I have been increasingly hearing from investors, traders, exchanges, and off-exchange trading venues that we, as a commission, need to be boldly rethinking how our markets operate and how we oversee them,” Stein said in an e-mail. “I have heard a number of proposals intended to help our markets remain the most robust and fair in the world, and I will do what I can to make sure that the commission fulfills its duty to consider and, if appropriate, implement them.”
In addition to Stein, SEC commissioners Luis A. Aguilar, Daniel M. Gallagher and Michael Piwowar met with the group, according to the people.
Sprecher, 58, has emerged since ICE’s purchase of NYSE Euronext as a critic of the current system for trading stocks, a landscape dominated by automated traders who supplanted human market-makers after a decade of technology advances and changes in laws. In a speech before the purchase closed in November, Sprecher said U.S. equity markets are flawed because sophisticated traders are taking advantage of small investors.
ICE’s call to abandon maker-taker could face opposition from other exchanges, including Bats, the broker-owned operator of four exchanges that is challenging NYSE for the most market share. In an interview, Bats President William O’Brien said maker-taker is “regulated pretty well today” and doesn’t “create any truly irrational outcomes in the marketplace.” Bats spokesman Randy Williams declined to comment on ICE’s meetings.
“Everybody’s got a whole different set of vested interests here are really hard to untangle,” Tabb said. “I’m not sure that anything happens quickly on the SEC side.”
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