On January 7, a group of nine leading retail broker-dealers, banks, financial services firms and global market makers announced their agreement to launch an equities exchange, called MEMX, or Members Exchange.
The consortium includes Morgan Stanley, Fidelity, Citadel Securities, Bank of America Merrill Lynch, Charles Schwab, E*Trade, TD Ameritrade, UBS and Virtu.
The idea is to offer a simple trading model with basic order types, the latest technology and a simple, low-cost fee structure.
Given that there are already 13 exchanges and 45 alternative equity trading systems in the US, adding another one would not, at first glance, seem to be such a great move.
The incumbents – NYSE, Nasdaq and Cboe – control 60% of trading, and between them own all of the exchanges with the exception of the Investors Exchange, or IEX.
IEX was founded in 2012 by ex-RBC traders Brad Katsuyama, Ronan Ryan, John Schwall, and Rob Park and finally gained regulatory approval in July 2016. It was made famous by Michael Lewis’s book ‘Flash boys, published two years before.
Until MEMX receives its licence, IEX remains the only independent equity exchange in the market, with a less than 3% market share.
But this is not about how many exchanges there are, it is about how much these exchanges charge for the market data that they provide.
"The entity is intended to be for profit with relatively low margins,” says Vlad Khandros, global head of market structure and liquidity strategy at UBS. “Some other exchanges have margins well into the double digits, so it seems feasible to be competitive and viable."
Before the demutualization of Nasdaq in 2000 and NYSE in 2005, these exchanges did not charge clients for market data. It was only after 2008 when they became for-profit companies that they began to charge. This is the heart of the market’s grievance.
“This could be seen as one giant strategic threat,” Richard Johnson, vice-president, market structure and technology at Greenwich Associates tells Euromoney, “with the Members Exchange saying to the exchanges that they will come after their transaction revenue if they don’t cut data charges. However, I don’t think that it is just a threat. The owners of the Members Exchange are the ones who have been paying rapidly increasing fees and are not happy. This is an indirect attack on the other exchanges.”
Just how much do the exchanges charge? There are two types of fees: access fees, which cover direct access to the securities information processor feeds (SIPs), and use fees, which cover display and non-display data.
“The exchanges have tried to paint this debate as the exchanges versus Wall Street,” explains Sarah Sullivan, analyst on the financial services team at policy analysis and regulatory due diligence research firm Capstone DC in Washington. “They argue that the cost of trading is lower than it has ever been and that they have had to invest so much in tech that this needs to be paid for.”
According to a research paper published in August last year by Charles Jones, professor of finance and economics at Columbia Business School, a global investment bank with a wide range of trading activities that subscribes to all of NYSE Group’s proprietary integrated data feeds, as well as similar ones for Nasdaq and Cboe in order to display limit order books, provide trading algorithms and support an affiliated dark pool would pay $100,800 a month for NYSE data, $127,720 for Nasdaq data, and $37,000 for Cboe data (for 75 display-only devices and for non-display use in one non-display category).
“This is an insignificant cost for these types of investment banks, which measure their annual equity trading revenues in billions of dollars,” declares Jones. The research paper was financed by NYSE.
The crucial question, however, is how much this data costs to produce.
IEX caused uproar in the market on January 29 when it published a study examining how much it costs IEX to produce this data compared with how much the other exchanges charge.
The data services that the exchanges charge for fall into three categories: market data, physical connectivity and logical connectivity.
The research found that for market data, which includes depth-of-book data products, other exchanges charged between 900% and 1,800% more than IEX costs.
For physical connectivity, they charge 2,000% to 4,200% over IEX costs, while for virtual data sessions (logical connectivity) the charge is 500% to 1,800% more than IEX.
“This debate has gone on for years in an echo chamber that lacks much objective data, because much of the data that would be helpful is known only to the exchanges,” said Katsuyama, chief executive at IEX on January 29. “It is not possible to determine whether these fees are fair, reasonable and based on competition without a basic understanding of the economics of these products and services – first and foremost, what does it cost the exchanges to provide them?”
Lev Bagramian, senior securities policy adviser at Better Markets, a non-profit, non-partisan and independent organization founded in the wake of the 2008 financial crisis to promote the public interest in financial markets, seized upon the research in a February 4 letter to the SEC.
“IEX is in a unique position to have done this sort of analysis because, to run its own exchange, IEX is required to pay for market data and connectivity at levels that are similar to what other industry firms must pay,” he said. “The findings were eye-opening. The robust data in the report convincingly suggests that the fees these exchanges impose on market participants are neither fair nor reasonable, and that they go well-beyond what is necessary to produce and make available this data and connectivity services.”
Spokesmen for NYSE challenged the findings, stating that, “while IEX is free to cherry pick and conflate their numbers, the fact remains that the all-in cost to trade on NYSE is lower than IEX.”
John Ramsay, chief market policy officer at IEX Group, takes issue with this.
He says: “The way that exchanges calculate an ‘all-in’ cost is by adding up all the fixed costs of the type we described in our study and combining them with variable transaction fees, which are heavily affected by rebates and pricing tiers provided to some of their members, to come up with an average cost per share.
“The problem – and it’s really a pretty obvious one – is that nobody pays an average. The fixed costs discussed in our report are needed regardless of how much any particular firm trades, much like a gym membership.”
Gerald Lam, head of communications at IEX tells Euromoney that it is these fixed costs that distinguish it from the other exchanges.
“Exchanges have forced customers into a fixed-cost paradigm,” he says. “Fees are subscription in nature, so you are on the hook at the beginning of every month. Our pricing is completely variable – you only pay when you trade.”
MEMX is launching into an increasingly acrimonious fight over data fees between the for-profit exchanges and the clients that they serve.
At an SEC roundtable last year, Cboe president and COO Chris Concannon stated that: “In light of the recent unprecedented and unwarranted public assaults on exchanges, we now have less appetite for compromise.”
They might need to rediscover that appetite if the regulator’s interest in this particular dispute intensifies further (the SEC disallowed two proposed price hikes last year).
“The SECs role is to make sure that fees are fair and reasonable,” Sullivan at Capstone points out. “It was relatively unusual not to allow the fee increase last May and October, which would suggest that they are taking a closer look at the feeds.”In its March issue, Euromoney examines the market dynamic that has led to the launch of MEMX and assesses its chances of success. We also look at how the make-up of the data feeds fuels the controversy and at the prospect for greater regulatory involvement in this fight. Is SEC intervention the only way forward?