Does The Cost of Exchanges That Have Sub-1% Market Share Outweigh Their Benefits?


Get ready to start seeing quotes from a new venue, FINRA’s ADF (Alternative Display Facility).  The ADF (which has been around since 2002 but has been dormant since 2010) began displaying quotes on February 10th and will be the 14th  protected market center to display quotes.  Currently, LavaFlow is the ADF’s only active quoting and trade reporting participant.  LavaFlow, which is an ECN, used to display and report on the National Stock Exchange (NSX) but has decided to switch to the ADF.​  We’re not sure what caused LavaFlow to switch but we would venture to guess that economics had something to do with it.

The NSX, which is owned by the CBOE Stock Exchange (CBSX), tried unsuccessfully to block FINRA’s ADF from reactivating as a participant in the public quote.  In a comment letter , the NSX warned that, “By negatively affecting competition between ECNs and creating a large barrier to entry, the ADF Proposal unnecessarily and inappropriately impedes competition between markets.”

While their comment letter espoused the benefits of competition, it is more likely that the NSX was just trying to block the ADF restart in order to prevent LavaFlow from leaving their stock exchange. Once LavaFlow’s  migration to the ADF is complete, the NSX will have lost it’s biggest participant (approximately 70% of their flow).   This loss of volume is going to no doubt put the NSX’s business model under significant pressure.   In response, NSX is trying a desperate move to recover some of that lost business -they are inverting their fee schedule and will use a “taker/maker” model . This means that the NSX will essentially have the same business model as their parent, the CBSX .

The “taker/maker model” (which rebates the liquidity taker and charges the liquidity maker) is currently used by 4 other exchanges (BATS BYX, EDGA, Nasdaq BX and CBSX) and is a questionable business model.  The NSX is adding more complexity to the US equity market which is exactly the opposite of what Jeff Sprecher, the New NYSE boss, has recommended.  Bloomberg​ quoted Sprecher as saying:

You could really simplify the market by outlawing maker-taker pricing.  I don’t think it needs a holistic review” to do away with maker-taker.

We think that exchanges that have less than 1% market share  (Nasdaq PSX, CBSX, NSX, NYSE Mkt and the Chicago Stock Exchange) are questionable and the market should reconsider their value proposition. These sub-1% exchanges add a significant cost to the entire industry while providing very little liquidity.  Connectivity fees, port fees, direct market data fees and regulatory fees are all factors that market participants must deal with when connecting to the 13 stock exchanges.  Does the cost of these exchanges outweigh their benefits?