A pilot program designed to test exchanges' models for attracting trading liquidity is finally moving forward.
The SEC's five-person commission unanimously approved a transaction fee pilot, paving the way for the pilot's introduction across all U.S. equity exchanges. An earlier version of the pilot was recommended in July 2016 by the SEC's now-disbanded Equity Market Structure Advisory Committee.
"The time has come to move forward," SEC Chairman Jay Clayton said during a March 14 SEC meeting.
The vast majority of equity exchanges, such as those owned and operated by Intercontinental Exchange Inc.'s New York Stock Exchange, Cboe Global Markets Inc. and Nasdaq Inc., use a model known as "maker-taker," in which liquidity takers are charged a fee by the exchange while liquidity providers are given a rebate, to encourage traders to post orders.
The pilot will test how trading liquidity changes when the amount equity exchanges can charge market participants for "taking" liquidity from their order books is lowered.
That fee is currently capped at 0.3 cent per trade under Regulation National Market System. The SEC's pilot will test the effects of lowering that limit to 0.15 cent and 0.05 cent per trade. In a third test bucket, a group of securities will trade without any rebates or linked pricing, meaning an exchange cannot offer lower fees to market participants in return for a promise of higher volumes.
The pilot comes as a win for critics of the maker-taker model, who have argued that it creates conflicts of interest in how broker/dealers route their orders. Many institutional investors, exchanges and broker/dealers claim that maker-taker leads broker/dealers to circumvent their best execution obligations to their clients by routing orders to the exchange with the largest rebate and pocketing the difference.
"Unhappiness with this system has been bubbling up for years, frankly, from a lot of different corners," said John Ramsay, chief market policy officer of exchange operator IEX Group, Inc., in 2017. IEX, a frequent critic of the payment of rebates, will also be subject to the SEC's pilot program when it rolls out.
The SEC's approval comes months after executives at the New York Stock Exchange, Cboe and Nasdaq detailed concerns in a letter over the Equity Market Structure Advisory Committee's previously recommended access fee pilot, which slightly differs from the SEC's transaction fee proposal.
In the October 2017 letter, New York Stock Exchange President Tom Farley, Cboe President and COO Chris Concannon, and Nasdaq Stock Market CEO Tom Wittman argued that the maker-taker model allows exchanges to compete with dark pools for trading volumes and aids in price transparency. The executives said that the SEC's pilot should include data from broker/dealers and private trading venues such as dark pools. At the time, the executives said they hoped the pilot would last no longer than one year.
But the SEC's pilot will not collect data from dark pools, and only from U.S. equity exchanges. The pilot will last for two years with a "sunset provision" after the first year, in which the agency can assess the program's data collection and decide whether to move forward with its second year.
"The fact remains that fees and rebates are central to our national market system and why trading decisions are made," SEC Commissioner Michael Piwowar said during the March 14 meeting. "[But] the time has come for us to ask serious questions about limitations to our markets."
