Maker-taker pricing has become a well-established trading venue fee structure on both sides of the Atlantic in multiple asset classes and may soon be making its way to the Asia-Pacific region. But despite its widespread use there are lingering concerns about its distorting effects on trading behaviour.
The pricing mechanism was popularised by US electronic communications networks and has since been adopted as the de facto standard among Europe’s multilateral trading facilities. The Australian Securities Exchange is also considering using maker-taker pricing for its PureMatch high-frequency order book, scheduled for launch in Q1 2011.
While paying rebates for passive order flow may seem like a shrewd way for fledgling trading venues to gain a foothold, it can tempt brokers to go rebate-hunting at the expense of best execution for their clients.
The access charges for aggressive executions inherent in maker-taker schemes can also encourage brokers to internalise more flow and trade less on displayed exchanges. This is a particular issue in the US, where Regulation NMS’s order protection rule stipulates that orders must be routed to the venue offering the best price, meaning that the only choice for a broker is to pay up or internalise when a maker-taker venue has liquidity at the national best bid and offer.
Some have attributed the slump in the Nasdaq Stock Market and New York Stock Exchange market shares last summer to a reluctance to trade low-value names on venues that charged high taker fees.
In the US options market, maker-taker critics suggest that brokers’ desire to avoid taker fees could push the passive orders on maker-taker venues to the back of the queue, as traders scramble to hit the bids and offers on the free-to-trade venues first.
Furthermore, maker-taker pricing can distort the market’s view of where the true best price is in instances where the fee or rebate per share is greater than the minimum tick size for a stock.
But is the problem overstated? After all, large brokers acting on behalf of the buy-side are generally net takers of liquidity and are not pursuing rebates.
High-frequency electronic market makers, which typically trade on a proprietary basis and therefore do not have to concern themselves with best execution obligations, are generally net posters of liquidity and are considered the main beneficiaries of maker rebates. The London Stock Exchange (LSE) is thought to have dropped its maker-taker pricing scheme, which ran from September 2008 to September 2009, because of complaints from its biggest broker clients, who felt they were subsidising high-frequency firms’ trading strategies through payment of aggressive fees.
Equally, it would be unfair to single out maker-taker venues for trying to influence where brokers trade. Traditional European exchanges that shun rebates have long offered volume incentives. Furthermore, in Europe, both brokers and their clients are bound by best execution obligations under MiFID, obliging buy-side traders to ensure their intermediaries are achieving the best possible result for the end-client.
Increasing regulatory demands for trade data transparency and ever-growing sophistication of transaction cost analysts tools make it even harder for brokers to deviate from the pursuit of best execution. But brokers can only be held to account if the best execution policies of institutional investors are clear on the kinds of venues they are willing to participate on.
To vote in this month’s poll on trading venues, click here.