The new firm’s stated aim is to offer a simple trading model with basic order types, the latest technology and a simple, low cost fee structure; but just how it plans to do so remains unclear. It has nine members: Morgan Stanley, Fidelity, Citadel Securities, Bank of America Merrill Lynch, Charles Schwab, E*Trade, TD Ameritrade, UBS and Virtu. There are many notable absentees, including Goldman Sachs and Citi.
Revenues at the incumbent exchanges have grown by 5.4% per year since 2010, with non-transactional revenue (data, tech, listings and fees) now greater than transactional revenue. The number of brokers in the US has fallen by 24% over a similar period, according to Finra. So, this growth in data revenue is being paid for by a shrinking pool of clients. Larry Tabb, founder and research chairman of New York-based capital markets research and consulting firm Tabb Group, says that the launch of MEMX is understandable. “This is standard practice in the industry,” he says. “When certain interests start charging too much, especially in a concentrated market, the brokers that use these services bond together and create competition.”
The crucial question, however, is what kind of margins the exchanges are making on their data feeds, which are simply regenerated from the trading activity of their own members. The Investors’ Exchange (IEX) which does not charge for market data, caused uproar in the market on January 29 when it published a study examining how much it costs IEX to produce similar data and compared with how much the other exchanges charge.
The topic of exchange data charges is one that many market participants want the SEC to take a closer look at, encouraged after it disallowed two proposed price hikes last year. “Around that time [October] the SEC moved to challenge the rationale for numerous exchange market data fee hikes – that was a material announcement. There appears to be focus from the Commission on market data more broadly. We believe they will continue to encourage increased transparency and competition,” says Vlad Khandros, global head of market structure and liquidity strategy at UBS, a MEMX consortium member.
The fastest way to get exchange approval is for MEMX to have a cookie cutter, maker-taker structure. It has explicitly ruled out incorporating a speed bump like IEX did, which slows trading by 350 microseconds and delayed the latter’s licensing by two years. However, Gerald Lam, head of communications at IEX, argues that new entrants need to innovate – just being cheaper is not enough.
Many see MEMX as simply BATS 2.0. But there is an important difference – retail. “Within MEMX there are three big firms that sell retail order flow and two big purchasers of retail order flow,” points out one market expert. If the SEC’s transaction fee pilot results in a world where exchanges cannot rebate customers for posting liquidity, it will make much more sense for retail firms to own the exchange function than it does now. “If payment for order flow goes away the retail brokers will want to have their own exchange,” says the expert.
The pilot stems from the widespread belief that brokers route based on the highest rebate on offer, rather than on best execution. There is increasing pressure for order routing disclosure and if rebates were banned, it would fundamentally change the economics of the business for retail brokers. Unsurprisingly, the exchanges hate it, with Nasdaq and CBOE having declared that: “Government rate making is a discredited vestige of intrusive, Depression-era legislation.” They are not alone in their disapproval. Goldman Sachs has criticized the pilot as costly and complex, and simply wants a reduced fee cap instead. Others are much more enthusiastic. “The SEC pilot could give market makers the ability to manoeuvre and create a new structure,” points out Tabb. “It could give them a way to create different sets of incentives that don’t look like rebates.”
At the heart of the issue are the securities information processor (SIP) feeds. “Just 2% of customers will trade on SIP data only,” Richard Johnson, vice president, market structure and technology at Greenwich Associates tells Euromoney. “But 34% said they would trade only on SIP if there was clarity that this was best execution.”
Tabb believes that the time has come to revisit the SIP. “The SIP is not fit for purpose,” he tells Euromoney. “But there is little incentive for the exchanges to improve the SIP as the worse it is, the more people have to buy the direct sheet data. If they changed the structure of the SIP governance committee so that the exchanges represented less than 50% of the committee, then they could redefine what a SIP is, which should increase exchange direct feed competition, and bring down pricing.”