The US regulator is proposing major structural reforms – and not everyone is happy about the current plans. Last night Cboe Global Markets issued a letter to the SEC to stress its “strong disagreement” with the perceived attack on exchange pricing practices. BEST EXECUTION spoke to Adam Inzirillo, head of North American equities, to learn why he believes reducing access fees is a “myth” that won’t improve market efficiency.
The US Securities and Exchange Commission (SEC) has embarked upon a radical series of market structure reforms that, if passed, could change the US equities landscape. Proposed on 14 December 2022 and with the consultation period closing on 31 March 2023, among the four separate proposals are a Best Execution regulation, which would establish a best execution regulatory framework for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers.
Tick size
Alongside this, the SEC has proposed fair and open auctions, new disclosure requirements, and – crucially for this story – a new tick size regulation that would amend certain rules under Regulation NMS to adopt variable minimum pricing increments (tick sizes) for the quoting and trading of NMS stocks. The regulator claims that this will “reduce access fee caps for protected quotations and accelerate the transparency of the best priced orders available in the market”. But not everyone is happy about it.
Cboe Global Markets has come to the fore with a comment letter sent to the SEC yesterday expressing concerns around “a specific narrative” put forward by a “vocal minority” in response to the tick size proposal.
“It would be plain wrong for a series of expansive rulemakings focused on sweeping changes to the equity market landscape to devolve into a narrow attack on exchange pricing practices, especially as exchanges continue to compete for an increasingly smaller addressable share of the market,” said the letter, seen in advance by BEST EXECUTION.
Cboe argues that current exchange fees and processes are among the most regulated and transparent in the industry, with access fees enabling exchanges to develop pricing schedules and mechanisms (including rebates), which allow them to compete with off-exchange market centers – and with rebates themselves result in directly narrower spreads and increased liquidity.
“Reducing the ability of exchanges to compete could directly result in more volumes migrating to off-exchange market centers and will have price discovery implications,” said the letter. “Regulatory intervention aimed at exchange fee pricing is unjustified, contrary to congressional intent, and would harm a generally well-functioning market.”
In particular, Cboe has urged the regulator to consider how any change might impact overall market dynamics. Options could include the SEC either re-proposing the new rules with relevant changes, or formally approving something close to its initial proposals, which did not originally include exchange pricing revisions.
An inside view
We spoke to Adam Inzirillo, head of North American equities, to learn more about the specific concerns around exchange pricing.
“One initial proposal was focused on narrowing tick sizes, but then we saw a lot of analysis come out of that,” said Inzirillo. “The suggestion was that the SEC should take an empirical approach around names that are tick constrained, narrowing the spread down to around half a penny for around 60-70 names. But the SEC took quite a broad stroke approach and narrowed it down to half, then two tenths of a penny, then a tenth of a penny – and then they also wanted to change access fees across those buckets including stocks below $1. What happened was that a lot of commentators ended up saying that any tick regime change should really just focus on the tick constraint names. Similar to what happens in Europe, where it gets recalibrated regularly and that helps determine tick size. But rather than just arbitrarily moving everything to these buckets, we felt they should use statistics to make that determination.”
While many agreed with Cboe, others supported constraints but suggested access fees should come down to a tenth of a penny (or spot 0.001), versus where they currently are today (spot 0.003). This focus on pricing is a theme that recurred throughout many of the responses to the SEC during the consultation period for the market structure reforms (which ended 31 March).
But Inzirillo disagrees. “We believe that pricing is just one component. Every industry participant has the ability to either trade off-exchange, or execute on their own principal account, and they have the ability to route to multiple market centres. There should be other factors making that determination – if anything, reducing this to price will push more trading activity to off-exchange venues and fragment the market even further.
“There is a myth out there that brokers route orders solely based on fees. But fees are just one component. Institutions, whether you’re an asset manager or pension fund manager, or macro systematic fund, might route to brokers because they have scale, or because they want to use them to pay for other products and services, among many other reasons. And brokers want to perform properly on those orders, whether it’s going through an algorithm or whether it’s going through the cash desk, which they might use in times of significant times of volatility.
“We believe that the SEC should focus more on disclosures and transparency. Exchanges are highly regulated entities, while approximately 25% of equities trading volume execute on venues which have no regulatory filing requirement. If there truly is a problem around how brokers are routing and they’re not solving their fiduciary obligation to find best price, then FINRA or the SEC should be dealing with a broker on these routing practices, not focusing on exchange fees or rebates. In theory, if the brokers are not routing in the best interests of the customer, changing those fees won’t have any impact. So we think it’s very short-sighted to solely focus on fees.”
The SEC has reportedly put the issue on the table for its upcoming RegFlex regulatory agenda meeting in October, focusing on rebates for agency orders.
“We think rebates are a good way for us to compete with other exchanges and to compete for order flow going to off-exchange venues,” said Inzirillo. “One important statistic is that over the course of the last three to five years, the total addressable exchange market is down over 500 basis points. That means more workflow is going off-exchange. So if you take away exchanges’ ability to compete based on explicit prices to attract the order flow, you may see that number increase, and you may see spreads widen. Those would be the unintended consequences of this.
“If it truly is a problem for brokers and how they’re routing, we think the industry needs to show evidence that this truly is the case. It should be a function of the regulators working with the brokers to disclose that information, as opposed to just simply telling exchanges to fix our fees. Because if that truly is the problem, then in theory, then nothing will change at all, until they focus on the transparency of how brokers are handling their orders.”
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