Although market competition and structure are hot topics in the securities industry, a Wednesday fireside chat at the STA 2021 conference on the competitive landscape between brokers and exchanges with Jonathan Kellner, CEO of MEMEX, and Joe Mecane, head of execution services at Citadel Securities, focused more on agreement than on discord.
With some 16 equity exchanges making up 50% to 60% market share on any given day, 32 Alternative Trading Systems (ATS) making up about 10% and more than 3,000 broker-dealers making up 30% to 40%, “it appears competition is alive and well in our markets,” noted panel moderator Kimberly Russell, vice president, ETF Capital Markets, State Street Global Advisors.
The relatively recent influx of retail market participants also has brought changes, Russell noted, with some heavy trading days recording off-exchange trading at a market share of more than 50%. That phenomenon has stirred renewed concerns about market fragmentation and the quality of the public quote.
Those new retail investors are a significant force, Kellner agreed. “As a market operator, I’d love to see more flows come onto the exchange, obviously,” he said, but instead of focusing on the balance of market share, “we as an industry need to consistently make sure that the NBBO (National Best Bid and Offer) is robust” and includes as much information about what’s going on in the market as possible.
“The NBBO drives where trades go off,” Kellner noted, and “even when a trade is made off-exchange, it’s printed to the tape… So it is part of price discovery.” As for market segmentation, “We have to be careful what we are talking about, “ he added. Part of the debate is over the benefit of segmentation to retail investors, but it also benefits institutional investors.
This debate has been going on for decades, and “it is completely factual that retail investors have an unbelievably good experience compared to the broader market,” said Citadel’s Joe Mecane. “The market is intentionally set up to have a huge amount of economic benefit to retail investors.” But the question to ask is, “Does that benefit to retail come at the expense of the broader market?” Mecane said.
“What I find personally disturbing is that we are not basing a lot of that discussion on data or analysis, but on philosophy,” Mecane said. “I don’t think we will ever be able to definitively conclude what is the right level of on-exchange or off-exchange, or is price discovery impaired.“ Instead, he suggested looking at why it happens. “Some of that is the growth of retail overall, some of that is just the evolution of the market.”
How can equity exchanges compete?
If some of that off-exchange trading happens because investors are allowed to trade in different increments, Mecane said the industry should look harder at offering solutions, including implementing half-tick quotes for on-exchange trades.
MEMX proposed that change to the Securities and Exchange Commission in a filing in late August of this year and also published a study, “Market Structure Report: Examining the Tick Constrained Securities Issue,” that argued that Rule 612 of Regulation NM needs to be updated. Rule 612 prohibits market participants from displaying, ranking, or accepting quotes for orders in any NMS stock priced in an increment smaller than $0.01 if it is priced equal to or greater than $1.00 per share. Citadel Securities is a member of the consortium of broker-dealers, banks and financial firms that backed MEMX’s launch just over a year ago.
Many industry insiders also support round-lot reform, Kellner said, which is something MEMEX also advocates. A round lot is a standard unit of trading for stocks under SEC rules, generally any order of 100 shares or a multiple thereof.
“We talk to our members, as well as institutional investors, and they want to make sure they are interacting as much as they can with retail orders,” said Kellner, but they also recognize that the way the market is set up today has been good, and it has increased overall volume and is positive.
“There’s not so much frustration as you would think,” Kellner said. “The bigger issue for them is measuring…and the impact of their trades when there is a percentage of their flows that they can’t interact with” when they are thinking about what kind of position they can put on, or how long it would take to unwind it, he said.
Payment for order flow? It’s complicated.
Addressing two other key equity-market issues, rebates and payment for order flow for retail, Kellner said any decisions on rebates should be data-driven, but added that if it were not for rebates it would be easier for exchanges to compete. “It would make our lives a lot easier, but I think it would hurt liquidity.”
As for payment for order flow, Mecane said it would be “very difficult” to enact any reform around payment without a similar action around rebates. “The regulators hate” payment for order flow, but nothing has ever been done, he said. “There’s value to retail flow, and people want to extract the economic benefit from retail flow.“
“You cannot eliminate payment and not expect there to be an increase in commissions, in my opinion,” Mecane said. Retail investors would pay more without it, he concluded.