Nanoseconds, Higher Rebates and Co-Lo Discounts..Oh My!
The nanosecond. That is one billionth of a second for all you non techies. The WSJ has an article(Read WSJ article here) where they report that a tech company has a chip that could execute a trade in 740 nanoseconds. Those wild and crazy HFT guys just keep spending more and more money racing each other to the speed of light. However, since their industry has been so profitable, they have attracted many competitors that have started squeezing their margins. So, what does any good business do when they start to lose revenue and start having margins shrink? They start to cut costs.
For HFT, some of their biggest costs are the fees they pay to exchanges for transactions, co-location and market data. Exchanges have been gorging themselves on these HFT revenues for years. This is probably why they love the current fragmented market structure so much and want to keep it just the way it is. But their HFT clients have seen average daily volumes in the US equity market drop from over 10 billion shares a day last year to less than 7 billion shares a day this year. And of course, lower volumes mean lower revenue for the HFT industry. Apparently, they are complaining to the exchanges and want their rates cut. And the stock exchanges are giving in and cutting their fees.
How do we know this? Well, every time an exchange makes a change to their fee structure, they must notify the SEC. We constantly review the SEC public filings and recently noticed a few exchange fee changes:
1-NYSE Arca proposed changing their Tier 1 and Tier 2 volume requirements from numerical thresholds (millions of shares) to percentage thresholds of average daily volumes (http://sec.gov/rules/sro/nysearca/2011/34-64627-ex5.pdf).
Now to be fair, other exchanges had already done this and the NYSE Arca is just playing catch up. But the point is that the HFT’s are having trouble meeting the numerical share thresholds now that volumes have contracted by over 30% since last year and they need the advantageous rebate that the exchanges provide to them in order to capture their near risk free profits (Tier 1 clients receive a $0.003/share rebate and have a fee for removing liquidity of also $0.003/share).
2-NYSE Arca also increased the rebate by 30% for Lead Market Makers that provide UNDISPLAYED liquidity using a Post No Preference Blind Order (http://sec.gov/rules/sro/nysearca/2011/34-64627.pdf).
First of all, what the heck is a Post No Preference Blind order? According to the filing:
“PNP B Orders are undisplayed limit orders priced at or through the Protected Best Bid and Offer (PBBO), with a tradable price set at the contra side of the PBBO. When the PBBO moves away from the price of the PNP B and the prices continue to overlap, the limit price of the PNP B will remain undisplayed and its tradable price will be adjusted to the contra side of the PBBO. When the PBBO moves away from the price of the PNP B and the prices no longer overlap, the PNP B shall convert to a displayed PNP limit order.”
Got that? Sounds to us that NYSE Arca (a so called “lit” exchange) is trying to encourage more non-displayed order flow. Maybe they are trying to compete with all those dark pools out there. Either way, more non-displayed liquidity certainly does not help the price discovery process.
3- Nasdaq is having a June Co-Location sale. Between June 1, 2011 and June 30, 2011, Nasdaq will
waive their co-location installation fees (http://sec.gov/rules/sro/nasdaq/2011/34-64630.pdf).
According to the filing:
“The Exchange proposes to amend Rule 7034 regarding fees assessed for the installation of certain co-location services to further incentivize the use of the co-location services.”
One month co-location discounts, rebate incentives, lower volume tiers. All this doesn’t sound like a growing business model. Sounds more like desperate attempts by failed business models to hang on long enough so that some other desperate exchanges step up and try to merge. Maybe this little experiment in the for-profit exchange model is not quite working out so well.