next week the SEC’s market structure advisory committee will hold it’s first official meeting. The meeting will revolve around discussions of the trade through rule. Critics of trade through claim that it creates complexity, facilitates nascent marketplaces that add little value, and amplifies the opportunity for latency arbitrage. Those defending the rule, suggest it is vital in enabling new marketplaces to start up and attract clients and order flow.
In Europe, under MIFID 1, there is no official rule. Instead, dealers are obligated to post on a public website the list of all markets that will be considered when executing an order. That way, clients are able to ensure that their chosen dealer gives due consideration to those markets it deems reasonable, while allowing dealers to bypass any venue whose value add is clearly less than the cost of conectivity. Buyside participants can vote with their commission wallet on the matter of what markets need to be accessed. As such, marketplaces must compete for dealer flow based on total economics and differentiated models. Markets cannot subsist on the regulatory subsidy that is a trade through rule.
The key economic problem with a trade through rule, is the creation of a captive consumer situation. Typically when consumers are captive to one or more providers, the price offered is less than competitive. Anyone who has worked in a bank, and been captive to that banks FX or fixed income pricing, is familiar with this concept. When trade through was first implemented regulators, being wary of this pricing issue, capped active take fees as well as data fees from the trading venues. Because of the absolute insanity, that is maker taker pricing regulators also had to ban the intentional locking or crossing of markets. this ban on locking of Markets was necessary and well minded, in order to prevent rebate arbitrage strategies that effectively take advantage of sub Penny pricing using the rebates to profit off of trades at a identicle prices – i.e. buying and selling at the exact same price. Rather than respect the intent of the rule, equity marketplaces designed a variety of order types, aimed solely at intermediaries, designed to allow Q priority on each and every change. As such, the HFT intermediaries were able to own first look on all active stocks the vast majority of the time. Exchange operators – fucktards that they are – argue that without such order types HFT participants would have overwhelmed their technology with vast numbers of order replacements. Of course this is total bullshit. In truth exchange operators would have been able to design economic systems to disincent such message traffic. However, that would have put them at a disadvantage to their exchange peers in the constant and never-ending insatiable hunt for intermediary flow. The notion that the trade through rule necessitates complex order types lacks both imagination and intellectual honesty. However, whenever it is suggested the complex order types should be regulated as opposed to rubberstamped, the ass hats running said markets pipe up with fictitious concerns about the impact such regulation will have on market robustness. Exchange operators always use this argument when faced with a regulation that might possibly mute excessive intermediation. Apparently it is vital that any change which the marketplaces do not like is done slowly, incrementally,and only after due academic study. Interestingly no such concern is registered when the exchanges are creating the changes. So when exchanges offer new economics like the first taker maker model, there were no concerns over market robustness. But when other participants suggest limiting taker maker suddenly we need to take great caution. This asymmetrical standard is harming our markets, is based on absolute nonsense, and facilitates continued excessive intermediation in the most liquid stocks.
Before the SEC listen to a bunch of business model selling pundits, they should consider both the purpose of the trades through rule, and the nature of locked markets. Despite arguments that locked markets are high proficient and offer the tightest possible spread, locked markets are in fact incredibly inefficient. Lock markets represent, at least in theory, buyers and sellers with identical prices and no trade clearing. Of course in truth, the buyers and sellers don’t have identicle prices, as they are only willing to trade if they are provided a kickback. As only certain participants in ourmarket have the reasonable access to the kickback mechanism there is a symmetrical access to trick. The result variety of profitable arbitrage strategies that offer negative incremental value to the marketplace as a whole. This is why we need to protect the walk On my way!. markrms our Eco et rule, and to eliminate complex order types designed to offer up Q priority to a subset of market participants.
If we deem it important to spur competition from new trading venues we should have trade through, a ban on locking and no order types that grant first access to the new quote level. If we feel we have a metric shitload of trading venues already and don’t need, want or deserve more then go the European route. It really is that simple. If you want slightly more complex force all exchange groups to nominate a single venue in their group for protection, the rest need to survive on their wits, value add and quality of liquidity.
Oh and let’s put a quick ban on the direct data feeds that are priced in a manner only a very small group of HFT players can afford the,. Yeah NYSE im looking at you on this one. Your direct feed bullshit should be illegal, not just unethical. When you pull that crap you hurt our markets, which in turns harms our economy. Grow the fuck up and stop that shit.
Anyhow I just saved Jamil, the old dude from aarp and a half dozen academics a full day of discussion. You’re welcome.