Rational Arguments on Market Structure & Unintended Consequences

A calm, rational voice on market structure, but where is the coverage?

In a segment on John Lothian News, Peter Maragos of Dash Financial calmly makes two important points:  First, market data costs need examination, since it is illogical that, as technology costs per message have dropped, data costs have continued to go up, and, Second, calls for banning rebates are illogical since institutions, armed with proper information, can benefit from our market structure, which is the most liquid in the world.   Before delving into the content, I want to point out how sad it is that Peter’s intelligent, common sense arguments fail to gain mainstream press coverage, while the hysterical bleatings of Brad Katsuyama and his paid minions become major news stories whenever they are repeated…

With that rant out of the way, let’s examine both points.  First, market data, where Peter’s observation of lower cost to produce the data not making into user costs, is completely valid.  Of course, basic economics teaches us that oligopoly power will result in this pathology, so we should not be surprised.   His second point, that the SIPs must be improved to “fix” this problem deserves amplification, however.   On this point, there is a not-subtle issue, namely that the geographic dispersion of the main data centers needs to be addressed to make the SIP competitive with direct feeds.

To explain this simply, consider a router, which resides in Secaucus, making a routing decision about a Nasdaq stock.  It gets SIP data from one of the Bats exchanges, which also reside in Secaucus.  Currently that data needs to traverse the 40 miles to Carteret to be processed by the tape C SIP and return the same distance.  This means that even if the SIP was infinitely fast, the delay caused by the speed of light over the 80 miles renders it insufficient for routing purposes.  (The same scenario exists for routers in all three data centers.)  This effectively grants a monopoly to the direct feeds for routing users.   Thus, the ONLY way the SIP can effectively compete is for there to be THREE SIP instances, one in each main data center.   I should point out that, while he was not the first to say this, Michael Blaugrund of the NYSE (ICE) made this point publicly, at an industry event last year.  That deserves recognition, as it showed both intellectual honesty and a true concern for improving the industry from a leader in the SRO community.

On the topic of rebates, I agree with Peter’s conclusion, but need to make one clarification:  In order for institutions to be completely empowered, there is a need to improve order routing disclosure.   While sophisticated investors can receive routing fix tags and pass thru costs, most do not receive that information on un-executed orders, which is essential for a proper analysis.  To explain, consider an example where a firm has excessive rebates compared to fees.  It is only a problem if there is evidence that there are a lot of unfilled orders.  In that case, it would be suggestive of chasing rebates to the detriment of the client.  If, however, the vast majority of orders were filled, then there may not be a problem.   Thus, my point is that if brokers were required to publish data, grouped by order type, including fee data and order routing statistics such as fill rates and price improvement, then institutions would be helped to make decisions.  Such a rule would help smaller institutions who don’t have enough data of their own and also would create a baseline template for the most sophisticated firms to use when conducting their own detailed analysis.

EU Regulators “Unintended Consequences”

FN News published an article making a valid point about the unintended consequences of MiFID II dark pool regulation.  As regulators have seen, time after time, whenever they try to curtail a business process that exists for a reason, the markets adapt.   In this case, as XTX points out, the adaptation could well mean a step backwards for transparency, as Systematic Internalizers (Sis)  spring up like mushrooms in a forest after a rainstorm.

While the EU regulators clearly dislike dark trading in general and broker crossing networks (BCNs) in particular, they exist for a reason; BCNs were created as an adaptation to electronic markets to facilitate broker’s ability to help their own customers by matching orders instead of crossing the spread and paying exchange fees.   (Admittedly, BCN development went beyond that, by including external market makers, but that was how they started.)  Next year, however, brokers who wish to provide enhanced services to their clients will be forced to do so under the SI regime.  Not only will this likely create a massive uptick in fragmentation, but also a dramatic rise in complexity.  This is due to the fact that an SI can offer different prices to different clients or classes of clients.  This means that both smart order routing and best execution reporting will need to take each individual client type into account.  If that wasn’t difficult enough, there will (at least at first) be no standardized definition of client type, meaning that both will need to be customized for every individual client.  Good Luck!


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