Almost two-thirds of participants in the latest theTRADEnews.com monthly poll agreed that payment for order flow by trading venues does distort the market. A total of 63% of respondents to our May poll concurred that competition for business between trading platforms had the potential to negatively impact execution quality.
Payment for order flow has been a sensitive issue in financial markets wherever competition exists between trading venues. Part of the reason for introducing penny pricing in the US equity options market, for example, was to narrow margins so that payments could not be made by market makers and exchanges to obtain order flow from brokers. But the introduction of maker-taker pricing structures by some equity options exchanges has caused controversy with critics suggesting that the brokers’ desire to avoid taker fees could push the passive orders to the back of the order queue on maker-taker venues, as traders attempt to hit the bids and offers on free-to-trade venues first.
In Europe, competition between incumbent national exchanges and the pan-European multilateral trading facilities (MTFs) launched since 2007 has also led to questions being raised about the impact of the newcomers’ pricing models.
In May, Cees Vermaas, executive director of sales and relationship management for European cash markets at global exchange group NYSE Euronext, called on the European Commission’s competition authorities to investigate the use of maker-taker price models by MTFs, which pay brokers for placing liquidity, but offer rebates for passive order flow.
Vermaas equated the availability of maker rebates to MTF clients with payment for order flow and argued that the fact that the pricing strategy would not be permitted for exchanges with a dominant market share created an uneven playing field.
“If you become successful and you have volumes which are comparable to those of the incumbents or established platforms, we think this [offering maker rebates] is an issue for the European Commission, which should look at payment for order flow,” Vermaas told theTRADEnews.com.
From the perspective of buy-side traders, a major concern is that fierce price competition between European trading venues could result in order flow being directed to venues that offer the lowest costs to brokers rather than the best price for their customers. However, both MTFs and exchanges are free to offer volume-based price incentives and as such brokers are increasingly being asked by buy-side clients for venue-specific details of the executions achieved by their smart order routers.
In the US cash equities market, maker-taker is not without its critics either because it can encourage brokers to internalise more flow and therefore trade less on displayed exchanges. Because Reg NMS’s order protection rule stipulates that orders must be routed to the venue offering the best price, a broker must either internalise or pay access charges for aggressive executions when a maker-taker venue has liquidity at the national best bid and offer.