The SEC’s Equity Market Structure Advisory Committee (EMSAC) just received, from its Regulation NMS subcommittee, the framework for a potential Access Fee Pilot. You can read the subcommittee’s framework memo here.. You can also read a little background on the Maker Taker Pilot on Flextrade’s Blog, written by Ivy Schmerken.

The Reg NMS Sub Committee makeup is here.

Members:

Kevin Cronin (Chair – Invesco)

Mehmet Kinak (T. Rowe Price)

Joseph Mecane (Barclays)

Eric Noll (Convergex)

Joe Ratterman (BATS)

Nancy Smith (AARP)

Chester Spatt (Carnegie Mellon Tepper School of Business)

Gary Stone (Bloomberg)

Why Is The SEC Considering Implementing An Access Fee Pilot?

You might recall that Themis Trading was among the very early critics of the maker/taker pricing systems employed by stock exchanges; in fact one of the recommendations we made in our book, Broken Markets, was to do away with the entire rebate/take system, as we have always believed it to distort price discovery, and certainly distort order-routing decisions. The idea of a Maker Taker Pilot has thus been around since 2012.

Maker Taker has been a very contentious building block of our modern market structure, and the SEC has tasked the EMSAC to examine the feasibility of a potential test pilot, where access-fee market structure effects can be studied empirically.

The main goal of this potential pilot is to collect real data, and to study and ascertain:

1          The relationship among access fees, liquidity provision, and market quality.

2          The relationship among access fees, rebates, and order routing practices.

3          The effect of various access fees on price discovery

How Will The Access Fee Pilot Potentially Be Structured?

The Pilot is being proposed with four (4) buckets of random securities, which will be greater than $3 billion in market cap, so as to not conflict with the possibly concurrent Tick Pilot mandated by Dodd Frank. Its length is recommended to be one or two years. The four proposed buckets are as follows:

• Control Bucket (status quo – 30 Mil Access Fee Cap)
• 20 Mil Access Fee Cap
• 10 Mil Access Fee Cap
• 2 Mil Access Fee Cap (possibly 5 Mil – depending)

The fourth bucket (2 Mil Access Fee Cap), is designed to imply the existence of no economically significant rebate. The rebate could be mandated to be “zero”, or instead left to the exchanges’ option – the thoughts being, why would an exchange choose a high rebate (say 33 Mils) when its take fee is capped at 2 Mils.

What Are Some Key Issues the Subcommittee is Grappling with in Creating This Pilot?

First, there are two issues that are still not worked out in the subcommittee:

• Should rebates be prohibited in the 4th bucket? If they are prohibited, should the cap fee be raised to 5 Mils?
• Should the Access Fee Cap in all buckets just be applied to the “standard exchanges” – i.e. NYSE, ARCA, BATS, EDGX, NSDQ – or should the cap also apply to “inverted exchanges” – i.e. BATY, EDGA, BOSX

As the subcommittee currently has not reached consensus on these issues, the subcommittee suggests that the SEC solicits public comment, should the pilot be proposed.

Second, if rebates are not prohibited in the 4th bucket, and if the Access Fee Pilot does not apply to inverted venues, then the subcommittee advises that the SEC keep a close watch on order flow patterns, so that behavior does not migrate in such a way as to make the Pilot futile.

Third, the subcommittee believes that the same Access Fee Caps should apply to both displayed and undisplayed order flow on the exchanges.

Fourth, the subcommittee recognizes that Exchanges and ATSs are not on the same playing field. It would be unfair to impose a cap on exchanges, and not impose a cap on ATSs. The subcommittee has not reached consensus on this issue, which is not surprising. Therefore, the subcommittee suggests that the SEC solicit public comment on whether to not to impose the Pilot on ATSs as well as exchanges.

Fifth, the subcommittee has been pondering whether this Pilot should include some element of “Trade-At”. They have decided that it should not for several reasons, the two most important being:

• This Pilot is in part conceived to determine if down the road a Trade-At provision for non-displayed liquidity is even needed.
• Including Trade-At would make this Pilot too complex. Trade-At is addressed somewhat already in the Tick Pilot; why duplicate?

Sixth, the subcommittee advises that the SEC be at the ready to halt the Pilot once started, should unintended negative consequences accrue to retail investors.

What Will the SEC’s Measurement Criteria Be for This Pilot?

The SEC will be watching:

• Spreads – quoted and “effective”
• Changes to Displayed Liquidity at the NBBO, and multiple levels out
• Volatility – number or NBBO price changes
• Incidences of locked and crossed markets
• Trading Volume
• Behavior Routing Changes – will market share be affected between venues? Will TRF and Internalization increase or decrease?
• Reserve book changes
• Price impact (slippage) of larger orders.

Themis Thoughts

• We appreciate the substantial conflicts of interest that must be overcome in designing a meaningful Pilot. For example, it can’t be easy for a few subcommittee members who operate ATSs to want to agree to have their ATSs included in an Access Fee Pilot.

• If ATSs were to be included in the Pilot, then so should non-registered off-exchange vehicles – like a few run by some high frequency proprietary trading firms and internalizers. Yet, how could the SEC accomplish this? The SEC regulates Exchanges. FINRA regulates Brokers. Some HFT firms are unregulated. You can see it gets complicated quickly.

• The timeframe for such a Pilot is still far off. Assuming the SEC listens to its EMSAC, they would likely propose the pilot as a rule – perhaps in the 2^nd half of 2016. They would wait for public comment, which takes months. Then they would propose the official rule – perhaps in early 2017. Implementation might take place in late 2017, or even 2018. Thus, we are still looking at a few years for an implemented pilot.

• Again, two SEC Commissioners terms expire in 2017 and 2018 (Stein and Piwowar), and two SEC Commissioners have still not been confirmed to replace Gallagher and Aguilar.

Consider: the Pilot, should it be implemented, will run under a new regime of Commissioners, and will likely not be concluded when Chair White’s Term expires in 2019.

• We are excited to see this bold undertaking, and think it is past due. The SEC deserves credit for recruiting the EMSAC and tasking them to design a contentious idea that is certainly not universally appreciated in our industry. Kevin Cronin is the appropriate leader and investor advocate to chair this subcommittee. Those who know him find him always reasonable, always direct – cutting to the meat on any issue, and a passionate leader. If a Pilot can be designed, so that it actually gets off the ground, Cronin is the man in the arena to get it done.