Last month, the London Stock Exchange Group (LSEG) released a 49-page paper discussing their view on the UK consolidated tape (CT) for equities, in which the exchange attempted to deter the Financial Conduct Authority’s (FCA) consideration of a market-wide request for a pre-trade equities CT. However, while LSEG pointed to the challenges, the paper did not provide constructive suggestions.
Healthy development of the industry should not only focus on latency or the velocity factor, but also the three other aspects of the 4 V’s, namely: veracity, variety, and volume. As the former chair of the US Securities and Exchange Commission (SEC), Mary Jo White, previously stated, there’s a need to “deemphasise speed as a key to trading success”.
For the greater good
Let’s discern the agreeable market phenomena in the report and the obstacles that hinder the greater good and healthy reform of the UK equities markets.
One premise of those who oppose pre-trade CT is related to aggregation distance/ location differential issues being inevitable or un-addressable. Yet, LSEG and the industry should be well informed by now that Time-Lock Encryption (TLE) can solve this problem.
TLE is not a speedbump, it protects time sensitive information from being decrypted prematurely. We are not asking any regulators to prescribe a certain technology. The FCA has full authority to mandate proper security protection over both CT and the trading venues’ proprietary products (PPs). Requiring synchronisation of both CT and PP in accordance with an ‘atomic clock’ and prevents the circumvention of security measures. It eliminates the problem of where the CT data centre is located.
Post-trade CT shows where the market ‘was’ – it is after-the-fact, i.e. not actionable. One can see the market faster with pre-trade transparency. Pre-trade CT and/or PPs enable market participants to seize opportunities on price stability and/or destabilising factors or indicators.
Consider CT as a compromise which can offer alternates to PPs and other value-added services (VAS), it should be affordable and widely available to the have-nots. If the have-nots are willing to commit their limited resources in using PP or VAS, price and availability of PP or VAS must be within reach and the functions should enable a reasonable chance for the have-nots to compete with the haves.
A healthy balance between the relative distance of CT, PPs, and VAS is critical, or else the haves will exploit the gap and exacerbate class conflicts and cultural clashes.
The ever-rising cost of data
Many of the functions of CT providers are performed today by constituents, such as the consolidation of proprietary data feeds and calculation of BBOs. LSEG’s self-interest to preserve their own turfs – including their subsidiaries MayStreet and Refinitiv – is understandable. However, one of the stated goals of the FCA is to “affect competitive pressures for existing sellers of market data, resulting in cheaper, higher quality and more accessible data for its users”.
LSEG is slick to argue that “the cost and complexity of taking direct feeds in the UK is more manageable” when comparing to the European Economic Area and the US. Is it “manageable,” or is it in essence, telling their clients to continue tolerate their rent seeking behaviours?
A better way to “manage” the ever-rising cost of market data/ PPs is by mixing-and-matching the use CT with selected PP(s) to optimise between cost and one’s trade appetite and style. PPs’ usage varied depending on whether one being a hunter (performance optimisers, asset gatherers), or is a farmer (asset maximisers, retail) types of firms along the industry value chain.
Performance optimisers, latency arbitrageurs, alternative investment/ hedge funds, etc. would want expanded core data like the market data infrastructure rule (MDIR) in the US, while they are unlikely to switch to CT and their demand for PP is inelastic.
LSEG presumption of sell-side would stay on direct feeds is an overstatement. If given the sell-side and buy-side a choice to use pre-trade CT, they would selectively drop usage of a certain PPs to save cost.
LSEG’s study, assuming a delay of 10 milliseconds, presents a dire picture: “Delay would cause the price to be incorrect by 9-18% of a spread (average 14%) and the volume displayed on the tape to be incorrect by22-25% (average 37%) […] translates to slippage of 9-19% (average 14%) of a spread in terms of weighted mid-point.
Looking at these numbers, it reminds one of these two NYSE studies – “Price improvement, tick harmonization & investor benefit” and “The Impact of Tick Constrained Securities on the U.S. Equity Markets.” One similarity can be drawn – both LSEG and NYSE studies are about ‘queuing and wait time at the checkout counters’ if putting in layperson terms.
Latency impacts
In recent times, Cboe has proposed that a pre-trade CT works and previously provided their views to measure latency impact in a report released in April 2023. We think slippage and other phenomena are related to capabilities differences between lit exchanges, multilateral trading Facilities (MTFs), systematic internalisers (SIs), single dealer platforms (SDPs), approved publication arrangements (APAs).
However not everyone shops at the centralised marketplace or sells their products there. Buying habits have changed and sellers are modernising their distribution channels (the shopping mall versus online purchase).
The SEC’s tick size/ minimum pricing increments proposal aimed at closing any minor differences between the different market centres’ capabilities in sub-penny trading that may be used as tactics to disrupt the quote priority.
If adopted, it will force almost all stocks to trade at least 4-8 ticks wide, amid NASDAQ and other research having indicated a stock has optimal trading with a 2-3 tick spread. However, this artificially altering the queue (equal waiting line at all checkout counters) may affect the “apparent,” not the real supply and demand for securities.
Not to be misunderstood, it is true that “if everybody is transacting off-market, there is no point in having markets. Markets exist to help price discovery, and price discovery requires accurate and comprehensive trading data.” One size does not fit all, the noumenon of “venue-by-venue competition” is indeed a brutal Warring States Period.
The waiting line at “checkout counters” are indeed not equal due to lit exchanges may continue to exploit their dominance in market data, connectivity, and/or in combination with access fee rebates, enhanced market making discount to selectively provide perks to the elites.
In racing to gain the edge over each other, other venues introduce a speed bump (e.g. liquidity enhancing access delayed), proliferate order-types (e.g. midpoint-extend-life order), come up with new business models (e.g. market-on-close) and create other privileges (e.g. exclusive access to certain pegging orders).
Regional disparity
The UK, US, and the EU are indifferent in terms of people jockeying around trying to make money, and different market centres use different ways to redirect order flow. Among them there could be formal or informal alliances.
There will be complaints about rules being skewed in favour of certain entities, as well as new way(s) to exploit or circumvent the rule. The UK and the EU do not have the controversial order protection rule like the US, the FCA does not necessarily need the same trade-through requirements but still provide essential investor protection if policy makers consider the Exchanges, MTFs, SIs, SDPs, APAs as different streaming platforms.
A consistent copyright licensing mechanism aligns and addresses the economic viability of a constituent. By putting a value on quotes and trades composition, different streaming platforms would give proper considerations (optimise reach to targeted subscribers/ market participants, while bear corresponding cost in using others’ copyrighted materials) to minimise price pick-off and prevent their exploit of economy of scope and scale.
It eliminates conflict of interest, ensures efficiency in deployment of resources, and harmonises different market centres. Market forces will determine the optimal subscription/ access fees by the different venues.
A growing pie means a bigger piece for everyone
Lastly, expanded core data under the US MDIR (including odd lots, depth-of-book, etc.) and the bureaucracy under the SEC proposed CT Plan Version 2 would undoubtedly heighten the cost of market data and cause dysfunctional of the CT. The UK and EU should learn accordingly.
Time-lock encryption and copyright licensing mechanism have proven successes in other industries to lower cost and improve all 4Vs. Let’s agree to revitalise and realign incentives and capabilities with all market centres for the greater good of the overall industry. The pie will grow and with a bigger piece for everyone.