Take your pick of maker/taker remedies
A New York senator is lobbying
the SEC to reform the maker-taker pricing model, but his proposed solution to
potential conflicts of interest is struggling for support.
Democrat Charles Schumer has
written a letter to Securities and Exchange Commission (SEC) chair Mary Shapiro
imploring her to address when he sees as a “major conflict of interest in
securities trading” that may be costing investors up to US$5 billion per year.
The study, called ‘US equity
exchange performance 2011’, states differences in exchange performance are
rarely considered by smart order routers that direct trades to the multiple
venues that trade US stocks.
Matt Samelson, principal at capital
markets consultancy Woodbine Associates, said the maker-taker pricing system
was causing brokers to make routing decisions often not in the investors’ best
interest. He urged money managers to take ownership of where their orders are
executed, rather than rely on brokers.
Putting clients first
Senator Schumer called on the SEC
to require rebates and other incentive payments be passed on to investors and
fully disclosed. The senator said he would consider introducing legislation to
mandate all such rebates be passed on to customers if the SEC failed to act.
“In the years following the
financial crisis of 2008 and the flash crash of 2010, investors are already
questioning the integrity of our markets,” wrote Senator Schumer. “It’s more
important than ever to ensure that brokers put their clients first, and not
pocket hidden rebates at the expense of their customers.”
The senator believed there should
be no incentive for traders “to profit at the expense of their investors”. He
said the SEC should make brokers pass on any payments they receive from trading
venues to their customers and fully disclose any potential conflicts they may face
in routing customer trades.
Woodbine’s study shows maker-taker
and payment-for-order-flow create conflicts of interest because brokers are incentivised
to execute trades on a venue even if it isn’t offering the best price. It also
shows customers have lost up to $5 billion as a result of “sub-optimal order
“I respectfully urge the
Commission to act as promptly as possible to ensure complete disclosure of all
such payments and require brokers to pass these payments on to their customers,
thus eliminating the potential for conflicts of interest,” wrote Schumer. “Some
disclosure is currently required, but it is not sufficient to ensure that
customers are fully-informed about the payments received, and routing decisions
made, by their brokers. If the Commission does not act, I will consider
introducing legislation to address this problem.”
Samelson said Woodbine had been aware
of Schumer’s letter but had not spoken with the senator’s office except to say
the firm was happy to speak with his office further, should they wish to do so.
“I don’t believe the senator’s
letter calls for a ban as much as to fix the issue,” said Samelson. “I think
there are several steps the industry and/or regulators could do before taking
the extreme step of banning this pricing.”
For instance, Samelson said
regulators could require exchange fees were passed on to security principals.
“This might go a long way to
removing this particular conflict, but it may cause other micro-structure
related issues,” he said. “Additionally, the regulators could mandate more
precise reporting or better record-keeping with respect to order handling, and greater
still transparency into brokers where client order handling is concerned.”
Writing in their joint blog Sal
Arnuk and Joseph Saluzzi, co-founders of institutional brokerage Themis Trading
praised Schumer for highlighting the issue, but asserted that his solution did
not address the underlying issue of high-frequency trading (HFT) firms
practicing ‘rebate arbitrage’. “Proprietary
high-frequency traders currently enjoy getting paid up to 1/3 of a penny per
share to ‘add liquidity’ in stocks like Bank of America. These rebates
have skewed asset prices and are responsible for countless artificial arbitrage
trades. Rebates are used as an enticement by the exchanges to lure HFT
clients to their exchange so that they could increase their market share and
sell other market data related products,” the said.
Themis called instead the maker/taker model to be replaced by a flat fee of 1/10 of a
penny per share when adding or taking liquidity. “This fee should offset any
revenues that the exchanges would be losing with the elimination of the
maker/taker model. By adopting a flat fee model, the problem of
fragmentation may finally start to get addressed,” the added.
The SEC has not commented
publicly on Senator Schumer’s letter.