It’s Time To Abolish The Maker/Taker Model
They are at it again. In their never ending quest to attract HFT volume, the exchanges are constantly offering new incentives for the big HFT firms to play in their sandbox. This time NYSE ARCA has decided to increase the rebate they pay for order flow from their largest clients. Let’s just give a refresher on what the maker/taker model is and why it was formed. Back in 1997, the Island ECN (which was formed by former SOES bandit Datek Securities) invented a pricing scheme to attract orders to their new ECN. They decided to pay a rebate to brokers who would add liquidity and charge a fee for brokers who would take liquidity. Every ECN and exchange soon followed and a standard fee schedule was established. Makers would get a $0.002/share rebate and takers would pay a $0.003/share fee. The exchange would pocket the difference which was $0.001/share.
Rule 610 of Reg NMS “limits the fees that any trading center can charge (or allow to be charged) for accessing its protected quotations to no more than $0.003 per share. The purpose of the fee limitation is to ensure the fairness and accuracy of displayed quotations by establishing an outer limit on the cost of accessing such quotations.” While Rule 610 limits the take fee, it doesn’t say anything about the rebate that exchanges can pay to HFT firms. Over the past few years, exchanges have used increased rebates as a way to attract more order flow. They have created ultra tier and mega tier levels that pay the best rebates but only for their highest volume clients.
Effective today, NYSE ARCA is raising their rebates that they pay for order flow for broker Tier 1 clients from $0.0032/share to $0.0033/share. Tier 1 brokers must provide liquidity on NYSE Arca that is 0.45% or more of the total consolidate average daily volume in a given month. This amounts to around 30 million shares per day. They also added a few requirements which are basically meaningless. One was a requirement that the cancellation ratio must be less than 30% but it excludes immediate or cancel orders (IOC) from this calculation. Of course, HFTs mostly use IOC’s when they are pinging for order flow so to exclude IOC’s makes this calculation meaningless.
Oversized rebates have distorted the price discovery process. They are also a main reason for smart order router conflicts. The maker/taker model has added to the trading noise that has crowded out the true supply and demand price discovery process. HFT’s can essentially make a profit by buying and selling a stock at the same price due to these rebates. Ever wonder why Bank of America trades 300 million shares a day? Ever wonder why it flatlines all day long? Now you know.
We believe that the maker/taker model is a relic and should be abolished. It should be replaced by a flat fee of $0.001/share that is paid whether you are making or taking liquidity. Exchanges will still make their money but the price discovery process will be less distorted.