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May 25, 2018
Transaction Fee Pilot: An Impact Assessment
After much anticipation, the SEC has proposed a “Transaction Fee Pilot,” which would impose additional price controls on exchange access fees and rebates. As proposed, all equity exchanges (but not alternative trading systems (“ATS”) or other over-the-counter (“OTC”) trading venues) would be required to reduce access fees and/or reduce or eliminate rebates on 3,000 stocks for a period of up to two years. While some commentators equate a lower access fee with a better trade price, we have seen little analysis of the Proposal’s actual cost or benefit to investors. To fill this void, we are presenting two approaches that attempt to roughly quantify the Proposal’s potential impact on investors.
The analysis involves numerous assumptions, and we welcome any and all feedback. First, we assume that a reduction in access fees will result in a reduction in rebates. Second, we assume that with a lower rebate, spreads will widen.
The widening of spreads is generally accepted as a cost to investors because of the related increased transactions costs, particularly for agency liquidity-seeking order flow. Importantly, a wider spread will result in higher trading costs for this type of flow regardless of whether the order trades on an exchange or an off-exchange venue that derives prices from exchanges.
As demonstrated in the chart below, we find that as access fees decline, the cost to investors will increase by at least $1bn, increasing to nearly $4bn should such changes be applied to the entire market. While all investors would absorb the costs of wider spreads, the benefits from the proposed reduction in access fees would accrue primarily to sell-side brokers and proprietary traders
Top-Down Assessment of Fee Pilot Proposal
We first estimated costs using a top-down approach, which applies the proposed Fee Pilot changes to current average market-wide statistics. We assumed that rebates on trades in securities in each proposed Trade Groups would fall by the same amount as access fees would fall. For Group 3 (the “no-rebate” group) we assumed that market forces would reduce the access fee to $0.0002. We expect Group 3 to settle at a rate below Group 2’s $0.0005 cap as there is no rebate allowed on the other side of the trade; we also note that flat-fee venues which charge both sides of a trade today are generally priced between $0.0000 and $0.0003. As shown in the following table, this yields a blended access fee reduction of $0.00082 per share.
In order to find the expected new average spread, we identified the following calculation to apply the impact of the rebate reduction to consolidated spreads:
New Consolidated Spread = Current Consolidated Spread + Rebate Reduction * 2
The Current Consolidated Spread is the median market-wide bid-ask spread, and the Rebate Reduction is the $0.00082 blended average fee change. The Rebate Reduction is multiplied by 2 as we anticipate market makers will adjust both their bids and offers to account for the new pricing structure. This calculation results in a 1.1% increase in average spreads, to 28.1 basis points (bps).
As noted by the SEC in its proposal, brokers that are subject to exchange fees and rebates generally do not pass those costs/credits to their customer. We therefore assess principal and agency flow differently as principal flow is impacted by both explicit exchange fees and spread costs, while the ultimate customer behind an agency order incurs spread costs but usually does not pay explicit exchange fees. We also assume that the principal flow benefit from the fee reduction applies to maker/taker activity, but the higher spread cost applies to all principal and agency flow in the market.
Our cost to investors is found by calculating the cost to cross the new, wider spread; our cost to principal traders is found by calculating the cost to cross the new, wider spread netted against the benefit from lower access fees. Spread costs here are considered to be ½ the quoted spread for liquidity-taking flow, per standard transaction cost analysis measurement of performance against arrival price.
Our results show, on net, an estimated cost of $1.08bn to the industry, of which $721MM would be incurred by agency flow.
We believe that this result is somewhat conservative, primarily due to the assumptions of 1) no change in quote size despite the wider spread, 2) no shift in venue market share, and 3) applying the NYSE and NYSE Arca principal/agency ratio despite the fact that the market-wide agency taking share is much higher. This second assumption likely limits our estimated cost substantially, as a quick glance at major retail brokerage firms’ 606 reports indicates that nearly all held market orders are executed OTC. These conservative assumptions are offset by the exclusion of taker/maker (i.e., rebate to take and fee to add) venues’ impact on principal flow, the assumption that all agency flow does not pay explicit exchange fees, and by not assigning any benefit to liquidity-providing agency flow from a wider spread. We also assume a representative amount of volume in each of the pilot groups, which could be incorrect in either direction.
The below chart shows the distribution of the spread cost increase and the access fee decrease for the proposal’s three groups compared to the current market average. This again assumes an even distribution of liquidity characteristics across stocks. The access fee paid by brokers is small relative to spread costs in today’s world, and could fall as much as 93% for Group 3 stocks.
Bottom-Up Assessment of Rebate Elimination
We also estimated changes from eliminating rebates across the market as a whole. We used a “bottom-up” approach that looked at the difference in quoted spreads for each stock trading on Cboe EDGX Exchange, Inc. (“EDGX”, which is a maker-taker venue) and Cboe EDGA Exchange, Inc. (“EDGA,” which is a flat-fee venue). EDGA and EDGX are very similar in that neither is a listing market, and both operate on the same technology in the same location. Accordingly, any differences in spreads between the two markets could be due to the different pricing models available on each exchange.
In aggregate, the EDGA average spread is roughly twice that of EDGX, but there is substantial variation by symbol. To account for this variation, we applied the difference in spread to the current consolidated spread for each symbol, capped that difference to 25%, and then further limited the maximum spread difference to the ratio of the primary exchange spread to the EDGX spread (these limitations were to account for the variance between venues and the fact that we are modeling a world with narrower differences in exchange pricing). The chart below shows the differences in average quoted spread between these two venues, the primary market and the consolidated quote.
We believe that eliminating rebates would widen spreads, as demonstrated by EDGA’s wider spreads relative to EDGX. Accordingly, applying this wider spread to current trading activity of all NMS securities on all equity exchanges would result in an impact of roughly $3.8bn per year, once again born largely by agency liquidity-taking flow. We also checked this result by setting all stocks to group 3 in the first model; our result in that case was a similar $3.7bn impact.
To recap, we have used two different models to assess the impact of reduced fees and rebates on liquidity-seeking flow. We find a $1bn cost from the proposed Transaction Fee Pilot, rising to $3.8bn should such limitations be applied across the market. As stated, any such analysis requires numerous assumptions, and we encourage input from market participants on how we could further refine this assessment of investor cost.
- Kevin Tyrrell and Steven Poser
May 15, 2018
A New Era of Trading on NYSE: Now Trading All NMS Securities
On April 9, 2018, the New York Stock Exchange broke with 225 years of tradition and began trading stocks listed on other exchanges. By April 25th NYSE was trading more than 8,000 total names across the NMS universe - over 5,400 of which were listed on Tapes B (regional exchanges) and C (Nasdaq). By the beginning of May, NYSE had achieved an average market share of 0.75% in Tapes B & C trading.1
Participant Types & Usage
The NYSE market model for Tapes B & C is similar to the existing model for NYSE-listed securities. While Tapes B & C names do not benefit from a Designated Market Maker (DMM), the NYSE Floor Brokers and Supplemental Liquidity Providers (SLPs) continue to play key roles and together account for nearly 30% of liquidity provision.
Across all participants, activity is slightly more concentrated in active names compared to more-established venues. The top 100 most-active Tapes B&C names on NYSE account for about 61% of total volume compared to 56% at other maker/taker venues.
Source: NYSE TAQ and NYSE internal data. May 1 – May 4 2018
Liquidity Concentration Results from Market Characteristics
NYSE currently offers two benefits for passively trading Tape B and C securities: 1) a relatively thin limit order book while participants adapt their strategies for the venue, and 2) the parity execution model. Orders entered via a Floor Broker share a portion of incoming order flow, resulting in quicker fills than standard price-time priority venues. This means that orders can get filled quicker and incur less immediate reversion relative to other venues.
The chart below shows short-term price reversion statistics for resting orders filled at the full spread (i.e., buying on the bid or selling on the offer). NYSE outperforms all other maker/taker venues on both Tapes B and C, showing results similar to inverted and flat-fee venues.
Source: NYSE TAQ. April 25 – May 4 2018
Strong Quotes from the Start
The NYSE market model has also facilitated strong quoting performance in the new symbols right off the bat. The chart below shows NYSE’s time at the inside for the most-active Tape B & C names. The full symbol rollout was complete on April 25; starting the next day NYSE was at the inside in these names more often, on average, than individual taker/maker or flat fee venues.
Source: NYSE TAQ. Data reflect the 200 most-active stocks on Tapes B & C. April 25 – May 4 2018
We expect market quality statistics such as time and size at the inside to continue to improve as more participants adopt the venue into their strategies, which should drive increased market share. We are going to continue to track our performance in active names, particularly those with long queues, where the differentiated NYSE execution model can add value.
Adding Tapes B & C to NYSE is the latest step in the on-going NYSE Pillar migration, to be followed by the launch of NYSE National and the transition of Tape A trading on NYSE.
1Source: NYSE TAQ. May 1 – May 4 2018
April 12, 2018
Can You “De-Fragment” Small Cap Trading?
The Treasury Department’s 2017 Capital Markets report recommended that “issuers of less-liquid stocks, in consultation with their underwriter and listing exchange, be permitted to partially or fully suspend UTP for their securities and select the exchanges and venues upon which their securities will trade.”
The argument for eliminating UTP trading is that the limited liquidity in these stocks could aggregate on one venue, reducing the friction associated with accessing a broad number of venues for a shallow pool of volume. However, many of these stocks are already highly concentrated on a small number of venues, so removing UTP trading may have limited impact on available liquidity.
We compared securities in the Wider Tick Pilot Control Group with issues in the S&P 100. As shown in the table below, exchange fragmentation is lower in less liquid securities, with the primary exchanges providing more than 43% of the total displayed quote size. However off exchange fragmentation, as represented by TRF market share, is higher in these same less liquid securities.
We also measured market concentration using a standard economic metric called the Herfindahl-Hirschman Index (HHI). This measure is 67% higher for the tick pilot group than S&P 100 issues when measuring share of liquidity provision by exchange at the national best bid or offer (NBBO). An HHI level above 2,500 is considered highly concentrated; less-liquid and active names are charted below against the wireless and supermarket industries to highlight the relative concentration in the quoting of these securities.
As shown above, primary listing venues already display a substantial portion of the quoted size in less-liquid names. At the same time, off-exchange trading is significantly higher in these names relative to active names, meaning the primary exchange is providing more price information to the market but not receiving a proportionate increase in executions. Aggregating displayed liquidity on a single venue, while allowing off-exchange trading to continue in its current form, could exacerbate this situation as queues lengthen and market makers have more incentive to trade off-exchange rather than compete to tighten spreads in the displayed market. We therefore believe that any such program to concentrate trading on fewer exchanges should be accompanied by rules requiring meaningful price and/or size improvement in the OTC market.
- Steven Poser
1We chose the control group, because securities in the test groups have seen a substantial increase in fragmentation as market makers seek to improve their queue position when providing liquidity.
2Sources: NYSE TAQ Data
FCC - Annual Report and Analysis of Competitive Market Conditions With Respect to Mobile Wireless, Including Commercial Mobile Services
Bloomberg: Little Reason to Fear Amazonopoly With Whole Foods Deal
April 5, 2018
Setting the Stage: Opening Stocks During Times of Stress
We’ve discussed the importance and liquidity of closing auctions, but during periods of high volatility the opening auction is also a key source of liquidity. What’s more, the NYSE opening process reduces investor transaction costs by tens of billions of dollars per year.
Opening auctions on NYSE, like IPO auctions and closing auctions, are overseen by the Designated Market Maker (DMM). DMMs can open a stock in an automated manner or, depending on the situation, run a manual auction to aggregate interest and open at a more iterative price. This is especially important for stock-specific events such as IPOs or openings after earnings, or when market-wide volatility increases.
To assess the opening auction’s performance, we analyzed price discovery on the most volatile days in Q1 2018 (Feb. 5&6, March 1&2, March 26-28) relative to price discovery on other “standard” days. We measured open price discovery by comparing the open auction price with the market VWAP over the five minutes following the open auction. As expected during volatile periods, slippage vs. the opening price increased, but NYSE’s opening price performance changed less than electronic venues such as Nasdaq. NYSE-listed securities’ slippage increased by seven basis points while Nasdaq price changes following the open increased by 15 bps.
We also did a more granular comparison, looking at similarly-priced NYSE-listed and Nasdaq-listed opens for the January 2, 2018 through March 28, 2018 period. In each price and volume bucket, NYSE-listed issues achieved superior price discovery at the open.
- Kevin Tyrrell
March 14, 2018
Primary Exchanges & Expiry: More Than Just an Auction Story
With the quarterly expiration approaching on Friday, we reviewed trading from the December expiration to see shifts in price discovery behavior. One widely-known market structure feature is the increase in volume on inverted venues at the end of the trading day, when inverted venues can approach 20% of S&P 500 volume at certain points.
However, during key trading periods such as quarterly expirations, the shares available at primary exchanges1 far exceeds that of inverted venues. We looked at the December expiration’s average quoted size at the NBBO from primary exchanges and inverted venues, and find that primary exchanges’ quoted size at the end of the day increased 38% vs. a standard day2 while inverted venues increased just 18%.
This additional pre-trade displayed liquidity results in more intra-day trading activity flocking to the primary exchanges. Primary exchanges see an increase in volume every day heading in to the closing auction, and the trend is more dramatic on event days such as an expiration. The below chart shows shares trading in the S&P 500 by time period, exclusive of closing auction volume.
- Kevin Tyrrell
1“Primary exchanges” refers to trading on the listed market (e.g., NYSE trading NYSE-listed and Nasdaq trading Nasdaq-listed).
2“Standard day” represents an average of December 1st - December 22nd trading activity, excluding December 15th
March 1, 2018
Liquidity Opportunities in the NYSE Closing Auction
While most people know that the NYSE Closing Auction is the single largest liquidity event in the U.S. market, accounting for more than 6% of NYSE-listed volume on a regular basis, fewer are aware of the additional auction liquidity available at nearby price points.
To highlight this effect, we show the cumulative additional liquidity available on various days in December for NYSE-listed Russell 2000 and S&P 500 stocks, with colors indicating the distance of the liquidity from the final closing price. The median spread for NYSE-listed Russell 2000 stocks is roughly 29 bps, meaning all additional liquidity represented in green and blue on the Russell chart are on average within 2 spreads of the final closing price. The chart shows that traders who seek out this liquidity, by leveraging a floor broker’s experience and capabilities or by submitting orders at various price points, can find material additional volume.
- Kevin Tyrrell