A Grand Bargain? Not So Fast...

A Grand Bargain? Not So Fast… The news that the ICE and Credit Suisse reached agreement on a so-called “Grand Bargain” caught the attention of market structure observers this week. It would have been hard to miss it, of course, as the two firms have undertaken a major marketing and media push to promote it. At first glance, one might think that KOR and Healthy Markets would be strongly behind this effort, as it calls attention to the primary issues comprising our platform:

  1. Market data feed reform with a focus on fairness, consistency and clarity;
  2. Greater transparency for ATSs;
  3. Elimination of the maker-taker pricing model; and
  4. The implementation of a trade-at rule.

While it is clear why the ICE would support such a set of changes, it is, at first, much less clear why Credit Suisse would do so. Upon closer examination, it actually seems that neither firm is sacrificing anything here, and that the term “Grand Bargain” is nothing more than marketing mumbo-jumbo.

Before delving into this, let’s first examine the substance of the proposed reforms, as they appear to come directly from the Healthy Markets Platform. While we certainly appreciate the apparent intent, we have some significant concerns as to details and specifics, primarily because there are so few outlined in this proposal.

While it is great to talk about “market data feed reform,” we must remind ourselves that, in this case, said reform is coming from an exchange that, in addition to being a conflicted market data operator, continues to use the SIP feed to calculate the NBBO. This disadvantages many participants using order types that rely on this price (such as midpoint peg orders). We are hesitant to trust that ICE/NYSE are fully adopting the Healthy Markets proposals for market data feed reform, particularly when they continue to be negligent in how they treat orders entrusted to them.

This issue is further exacerbated by their September 1st fee change that specifically targeted ATSs and broker crossing networks. In that filing, NYSE increased the maximum cost for these venues to receive proprietary market data (quotes and trades) from $7,000 to $27,000, per-month. This is an explicit move to increase the burden on brokers to do the right thing, and match customer orders using direct feeds (and the most recent prices), rather than the SIP. The ICE/NYSE needs to explain their hostility toward the use of direct market data feeds to price the NBBO when matching orders.

The next item in their proposal is increased transparency for ATSs. This is like Grandma and apple pie – good luck finding somebody who would disagree with such a proposal. The devil is, of course, in the details. There are few that would disagree with the ICE proposal, but it does not appear to go far enough.

The elimination of the maker-taker business model is an important step in the right direction, and we fully support this effort. However, we are adamantly opposed to government price controls, and view the access fee cap as that. The elimination of rebates should remove the need for an access fee cap. Competition should be allowed to find the appropriate equilibrium, provided the incentives for executing trades on-exchange are sufficient and appropriate. Access fees will drop significantly once rebates are eliminated.

This brings us to the final recommendation – the implementation of a trade-at rule. You would think that there would be a huge party in the Healthy Markets offices when a major exchange and broker/dealer stand up and argue for eliminating maker/taker and implementing a trade-at rule. We have been passionately advocating for these positions in various forms for the past 2½ years. The tick size pilot proposal was an eye-opening experience for us though, and our comment letter is forthcoming. In that proposal, the SROs clearly demonstrated that they cannot be entrusted with the design of new market structure rules, and certainly cannot be allowed to write a trade-at rule. Instead of attempting to simplify market structure, their trade-at proposal was simply more of Reg NMS layered on top of the existing NMS structure.

The trade-at proposal that the SROs agreed to is an absurd example of what happens when you allow for-profit firms with perverse incentives to design regulation. It simply does not work, and opens the door for extreme unintended consequences.

While we fully support a trade-at rule, such a rule cannot exempt retail orders and must be simple. It must reexamine the need for Reg NMS restrictions within the context of the new market environment that would be created. And it must take into account technology and routing advances that did not exist in 2005 when Reg NMS was written. The rule written by the SROs in the pilot proposal does none of this.

So the substance of this so-called “Grand Bargain” is questionable, but it must be laudable that you have firms coming together from different parts of the industry to compromise and sacrifice for the greater good of the market and the public….right? Right?!

Isn’t that the whole point behind the Healthy Markets Initiative?

Of course it is, but here we question whether either firm is giving up anything. We further question the sincerity of the proposed regulatory changes – are these firms really ready to push for substantial changes to Reg ATS, Reg NMS and possibly even the Acts of 1933 and 1934? Are they ready to withstand the fight from the other side on this issue?

The ICE certainly is not giving up anything with this so-called “Bargain.” They currently earn the spread between the rebate and the take fee, which is hard to quantify because of fee tiers, but is probably somewhere around 7 – 10 mils. Moving to 5 mils per side (10 mils total per trade) would actually represent an increase in per-trade revenue (or at the very least would not be a decrease). The addition of trade-at would mean far more volume going to the exchange, so this would be a bonanza for the NYSE and their new owners.

In fact, consider this – ICE/NYSE has a history of raising broker fees for market data and derives the largest part of their revenue from market data fees and technology sales. Once these changes come in, they could easily drive ATSs out of business, and then open the door for ICE/NYSE to continue this pattern of driving up the cost to receive market data and to use their technology. Once again, the devil is in the details as to whether their supposed “market data feed” reforms would address any of these issues.

If the ICE is reaping such rewards, surely Credit Suisse is making a grand, selfless gesture by accepting trade-at, and most likely the end of the Crossfinder Dark Pool….right?

At the surface, this appears to be a reasonable reaction, but in this industry (and in general) we should always question why a firm would do something that negatively impacts its bottom line.

It is well understood that there is tremendous regulatory and enforcement scrutiny of ATSs by any government agency that has any kind of jurisdiction. This, along with the increased cost of operating an ATS (thanks to market data fee increases and Reg SCI) portend the end of the dark pool landscape as we know it. Perhaps Credit Suisse has already accepted the inevitable, eventual close of Crossfinder and is merely holding its pool as a chip for a future settlement with enforcement authorities.

Such a move would make sense, especially with the consideration that Credit Suisse also operates an ECN, LightPool. This ECN is laughably marketed as a buyside venue, despite an average trade size (147 shares) far below the industry average (204 shares on ATSs) and even below Crossfinder (175 shares). LightPool will be the big beneficiary here, when CS simply redirects the order flow that was previously flowing to Crossfinder. If Credit Suisse was holding this out as part of a settlement with enforcement authorities, this should be disclosed immediately. Credit Suisse’s support is being hailed as a major sacrifice (or “Bargain”) and clear vindication that regulators should push forward. But this may be a disingenuous maneuver. It may simply be that Credit Suisse has decided to close Crossfinder and has figured out a fantastic way of marketing the event.

It is important to understand that Healthy Markets agrees wholeheartedly with the principles behind these proposals, as we have made clear with our platform and advocacy work. We further believe that a coalition of industry firms is the only way to push these changes. That being said, the substance of these changes is as important as the credibility of the firms advocating them, and we question both in this case.