Calling The Grownups – We May Have A Grand Compromise!



Sometimes, when parents don’t step in and keep order, children start testing their boundaries. Over time and little by little, they embark upon behaviors that aren’t really good for anyone in the long term – especially themselves. It sure seems like this happened with our capital superhighway – the stock market. A rule proposal approved here, a hidey-not-slidey approved there, and before you know it, just as in Lord of the Flies, kids are running around with spears and putting pig heads on a stick….

Modern market structure has such been an evolution where we have gone from a system of a few liquidity pools with diverse players swimming in the same pool, to a system of dozens of fragmented liquidity pools where players are siphoned off and segmented – with the purpose of creating the maximum amount of short-term alpha for a select few. Today, retail orders don’t often make it to a stock exchange. Today institutional orders are roped off in broker dealer algos that keep them in a pinwheel – spinning them around mostly in the dark. Today, stock exchanges, which create and reflect prices of the supply and demand of risk and capital, are dominated by short-term market makers.

Ok, you all know this. Investors and traders sort-of swim in different pools. About 60% of daily volume occurs on exchanges, with 15% taking place in dark pools, and 25% taking place in retail internalization engines run by firms like Citi, UBS, Citadel, Knight, and many smaller “HFT” players. It works on most days, but then again… on some days we see weird price moves and dislocations (flash crashes/dashes). We think those price moves and dislocations would not happen with fewer liquidity pools that have diverse participants.

This morning we want to point out an article in the Wall Street Journal titled NYSE Plan Would Revamp Trading. Rumored to be in the works for months, ICE/NYSE – the premier stock exchange family – and CSFB – the operator of the largest dark pool, are proposing a Grand Compromise:

–          NYSE would eliminate maker/taker – and instead charge a flat fee of 5 mils.

–          Banks like CSFB would accept a trade-at rule, which would push orders to the stock exchanges unless they can be meaningfully price-improved.


There are many positives to such a compromise:

–          The exchanges would benefit from a large increase in orders and volume on their platforms.

–          Fragmentation would diminish rapidly; the justification for so many bank-owned dark pools has been the need to internalize in order to avoid the high cost of taking and trading on the exchanges. With this compromise that need is diminished.

–          Public pricing of stocks would theoretically be more robust – as the exchanges would have more diverse participation – and not just high frequency “fleeting” participation.

–          The rules of the road (trading mechanisms, matching, order types) are fairly standard and disclosed on public exchanges. They are less-so in private dark venues.


We have called for such a compromise for nearly five years, and believe the benefits from revamping trading in the stock market far outweighs potential costs. NASDAQ is rumored to be supportive of this compromise, as is the premier high-frequency market maker – Virtu Financial:

Mr. Sprecher has received support from at least one high-frequency trading firm, Virtu Financial LLC. “Virtu believes the reforms proposed in the letter will go a long way to address many of the structural concerns that have been raised by market participants,” said Doug Cifu, CEO of Virtu, in a statement.

Global high frequency market maker IMC is also apparently supportive; its chairman Remco Lenterman tweets this morning:

“I agree with ICE wholeheartedly on this. Reduction in access fees need to be coupled with a trade-at provision.”


The Grand Compromise is not without criticism, however:

“Mandating trading on exchanges is an elephant-gun approach motivated by commercial interests of a handful of market participants,” KCG said in a statement Wednesday.


Of course, businesses that have geared their business models towards identifying “uninformed orders” and trading against them for profit are likely to be against this plan – in other words every retail internalizer (KCG, Citadel, UBS, Citigroup, and smaller “HFT” shops).

The Grand Compromise is a long way from being “in the books”. Currently it is just a Great Idea that we hope spreads and takes root. Ultimately, the Grownups will have to step in and exert leadership. Ultimately decisions will need to be made that put the welfare of the market over the welfare of select business models. Ultimately the children still need the Grownups to come to the island and rescue them from themselves.

Post Script: As you all know, exchanges increasingly have been thinking of themselves as technology and data providers. Cash trading has not been a large money-maker for any of them for some time. They will make most of their money in the future by selling data and technology solutions to firms connecting to trade on the exchanges. If and when the Grownups (regulators) bless this Grand Compromise, we hope they do it with one eye keenly aware of what might happen to fees for those connections and data feeds. There is always a VIG, after all.