In early January, BATS Global Markets, Inc. (“BATS”), the third largest U.S. equity market operating four equities exchanges, suggested significant changes to the U.S. market structure in an open letter to the U.S. securities industry (“the industry”). BATS also indicated that it would petition the Securities and Exchange Commission (“SEC”) to implement its proposed changes.
BATS suggested open and constructive dialog about potential market structure between industry and the SEC as a key factor in improving the U.S. equity market for all investors, while still providing for appropriate competition among markets and market participants. BATS also noted the growing concern within the industry regarding the amount of trading done away from the displayed exchanges and the incentives brokers received for routing orders to one destination over another.
Some market professionals have advocated for a “grand compromise” that would impose dramatic regulatory change in the form of a trade-at prohibition. This would force order flow to the exchanges in order to decrease access fees and ban exchange rebates for market participants. BATS believes this compromise would ultimately be harmful and more expensive to end investors. As the letter states:
BATS believes that a “grand compromise” between industry professionals would ultimately be harmful to end investors. While exchanges, including BATS, would stand to benefit from increased volume directed to them, and brokers would benefit from a reduction in exchange fees, investors will likely pay more both in the form of potentially wider spreads as well as fewer and inferior execution choices resulting from restrictions on competition.
As an alternative, BATS advocated for regulatory changes in the following areas: Access Fees, Order Handling Transparency, Small Trading Centers, and a revision to Regulation NMS.
BATS favors a reduction in the access fee currently imposed in Regulation NMS. The Exchange proposed a reduction of close to 80% for certain liquid securities. BATS recommended that any liquidity rebate be less for highly liquid securities. It is proposed an access fee reduction for the most liquid securities from 30 cents per 100 shares ($0.0030) down to 5 cents per 100 shares ($0.0005). For less liquid securities, access fee caps would be tiered based on a security’s characteristics. BATS argued that this approach would preserve the benefits of the current market structure while providing more opportunities to improve the trading experience for illiquid securities. Additionally, the access fee reduction in the most liquid securities would reduce incentives to route away from the exchanges.
To better inform investors with respect to their brokers’ order handling decisions, BATS proposed that all Alternative Trading Systems (“ATSs”) should be required to provide customers with their rules of operation. This disclosure would include full descriptions of order types, pricing tiers, all forms of order-routing logic, and transparent participant eligibility guidelines. Using this information, institutional investors could better determine if a venue and/or order routing product met their trading needs. These transparency initiatives, in combination with the access fee reductions discussed above, provided a more “elegant” solution to bringing volume back to the exchanges than the “grand compromise.”
According to BATS, all exchanges and ATSs, regardless of their size, have a significant competitive advantage by virtue of the “trade through rule.” The trade through rule, under Regulation NMS, requires all market participants to do business with all execution venues that display orders to the market. BATS argues that while in some cases the marginal operating cost for a “new” exchange is near zero, market participants may incur substantial costs when trying to connect to these small venues. To combat this problem, BATS proposed a revision to Regulation NMS that provided until an exchange or other currently-protected market center achieved greater than 1% share of consolidated average daily trading volume in any rolling three-month period: (1) it should no longer be protected under the trade through rule; and (2) it should not share in/receive any NMS plan market data revenue.
The result of implementing these provisions would serve two purposes. First, client costs in connecting to small exchanges and ATSs would potentially be reduced. This would give the small exchanges and ATSs flexibility to route around them if they chose to and also continue to protect displayed limit orders for the larger venues. Second, market data revenue that may be the basis for the continued operation of marginal venues would be taken away.
The ultimate goal of BATS’ letter is to generate feedback from the industry as well as garner support of its proposals before sending a petition of the proposed changes to the SEC.
The primary materials for this post are available on the DU Corporate Governance Website.
December comment letter: