Chair Clayton’s first speech gets a mixed review & how CHX and Themis are wrong (again)…

The chairman’s first speech

Jay Clayton’s first major speech as chairman of the SEC was a good effort and while I think he laid out a laudable set of guiding principles, Mr. Clayton should be mindful of #3 (protect long term investors) most of all.  The good news is that his concern over the lack of public listings is on the right track, since he correctly articulated the extra regulatory burden on becoming public, in a world where private capital is increasingly available.  His idea for forming a fixed income market structure committee also makes sense, although I will reserve judgement until after it is more formally proposed, as the devil is in the details.   The bad news is that his pointing to an SEC proposing a “maker-taker pilot without FIRST reforming execution quality disclosures violates his own key principal.  The reason is that, while a maker taker pilot makes sense theoretically, it is illogical to do so in a world without data available to measure it.    The chairman correctly identified that rebates are an incentive to provide liquidity, and that can be measured by current available data.  However, the main reason  for the pilot is to study how to “fix” the conflicts of interest faced by agency routing firms created by rebates and fee differentials.  Routing firms, you see, sometimes route to minimize costs (for aggressive orders) or earn rebates (for passive routing), instead of maximizing fill probability for their clients, which is what “best execution” would require.  Without reforming Rule 606 to require routing firms to disclose their execution quality stats AND fees/rebates for each type of order sent, however, it will not be possible to measure the impact of the pilot on routing behavior.   Not only does today’s routing disclosure OR the SECs recent proposal fail to do so, but most TCA vendors don’t either, as they look only at executions and ignore un-executed orders!  Simply put, the precise behaviors that the pilot purports to measure are not disclosed to the public, nor to most professional investors!


The CHX is at it again…

The CHX tweeted yesterday their letter to the SEC in support of their LEAD proposal and started with a misleading definition.  They called the fact that routing firms take their quotes last, meaning that their offer price becomes the bid price, “Latency Arbitrage”.  This use of the term is very misleading as it implies that those who “take” their liquidity make immediate, risk free profit, while that is NOT true.   A more accurate, but less persuasive term would be “price aware” trading, since what they are describing is the fact that their market maker’s orders on the CHX are often ranked last in the aggregate queue at the NBBO.   What is happening is that order routers, when they “take” the CHX liquidity do so, by definition, when the liquidity at that price is exhausted.  If the CHX market maker quote was on the offer, in most cases when their quote is “taken” that price becomes the new best bid.   Note that the “taker” does not immediately make money, since a sale at that point would be at the same price (and fees would turn it into a money losing trade, but the CHX market maker would be losing money (since a repurchase would be at a higher price).   What CHX is trying to accomplish with the LEAD proposal, is to let their market makers NOT be firm on their prices, to compensate for being at the end of the queue;  in short, to render their quotes misleading to the broader market on purpose to make up for systematic issues at their exchange!  Needless to say, this should not be allowed, since it would encourage ALL exchanges to do the same thing, making the NBBO into a mere suggestion…

I disagree with Themis, again…

Not surprisingly, I disagree with the Themis blog on Nasdaq ELO.  (Sorry for the day delay, but Sal blocked me on twitter, so I did not see the post yesterday; I surmise that is because I keep pointing out logical and data-driven flaws in their “analysis”)   Anyway, they state that the Extended Life Order, which is a voluntary order type, represents a conflict of interest since, presumably, it would harm retail investors if used.   First, even if they were correct, it is voluntary, and retail firms can measure the fill rates of these orders.  (If it turns out to be lower, then they can stop using it)  More importantly, they are likely wrong.  You see, liquidity takers want to take liquidity when retail is the predominant liquidity provider, since retail orders are less likely to have quantity hidden behind any individual order.   Therefore, if knowing that an order is retail, provides an incentive for liquidity takers to hit retail bids or lift their offers, that is a good thing from a retail client’s perspective.  Remember, the retail broker that routes those orders ONLY concern is maximizing the FILL rate of the orders they handle, not the post trade movement, so it is in their interest as well.  Thus, both the routing firm and their clients have the SAME interest and there is no conflict.

I am guessing that their real concern is that it will make institutional orders slightly less attractive to liquidity takers, and that is a valid, if extremely small, concern.  Going back to the chairman’s speech, the focus should be on long term investors, and retail investors are certainly part of that community.  In the U.S., the SEC has clearly approved the notion of segmentation to benefit retail investors when appropriate, and this seems to fit that broad mandate.  Second, institutional investors should be more concerned with getting liquidity than capturing spread, which means that they probably overuse limit orders in many cases, but that is a topic for another day…

It feels nice to be valued

Greenwich reports that buy side firms care about market structure.  That sounds good to me, as I am one of a handful of people that consistently evaluate and write about market structure, but call me skeptical.  While I am available to help any buy side firm that wants an in-depth understanding of market structure and enhance their trading strategies, the buy-side, so far, hasn’t been contacting us for help at ViableMkts



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