Maker-taker rises up SEC reform agenda

A new member of the Securities and Exchange Commission's leadership has highlighted reform to maker-taker pricing models as a particular issue the regulator should consider in its holistic review of US equity market structure.

A new member of the Securities and Exchange Commission’s (SEC) leadership has highlighted reform to maker-taker pricing models as a particular issue the regulator should consider in its holistic review of US equity market structure.

In a wide-ranging speech last week, Kara Stein, a commissioner since August, said maker-taker pricing – the mechanism by which brokers receive a rebate from venues in return for posting liquidity – is one key issue the SEC should address to strengthen US equity markets for end-investors.

“I have heard from many investors, and even exchanges, who are worried about the incentives embedded in the current system, and if there are proposals to explore alternative approaches, we should consider them,” she said.

Citing the need to form rules based on data, she added, “we should explore how the maker-taker pricing model impacts liquidity and execution quality. Does the current rebate system incentivise or penalise investors?”

Senior executives from the two top US equity exchange operators by market share – BATS Global Markets and the NYSE Euronext – have in recent weeks thrust maker-taker into the spotlight by voicing opposing views.

Jeffrey Sprecher, CEO of IntercontinentalExchange, which owns NYSE Euronext, believes maker-taker damages the market’s core function, while William O’Brien, president of BATS Global Markets and former Direct Edge CEO, has stated exchange rebate programmes were simply an aspect of a properly functioning system.

Fair game

Largely adopted by venues to gain market share, maker-taker pricing has the potential to create a conflict of interest between broker and client as the former may choose to direct a trade to a venue based in its economic interests rather than best price for the latter.

Jim Myers, senior manager of business consulting at Sapient Global Markets, sides with BATS’ O’Brien. By meeting best execution requirements set forth by the national best bit and offer (NBBO), brokers are not acting out of step with the interests of their institutional investor clients by selecting an execution venue based on rebates, he says.

“Critics claim it’s not in the end-investor’s interests, but provided all other aspects of the market are functioning properly, and the order is filled above the NBBO, then it makes no material difference,” Myers told

“Maker-taking pricing is simply another way for exchanges to differentiate themselves,” he added.

The SEC is expected to include the issue within a broad review of US equity market structure. But this ‘holistic review’, argues Matt Samelson, principal at capital markets research consultancy Woodbine Associates, says the maker-taker can be tackled on a standalone basis.

“The SEC has alluded to a holistic review, but in reality changes to maker-taker could occur outside of such a review and benefit the buy-side,” he said. “Maker-taker pricing can create a conflict of interest between broker and buy-side firm and impact the underlying fiduciary responsibility of institutional investors.”

To address this conflict, or learn of its true extent, asset managers must push for greater transparency of broker routing decisions, to see which venues were accessed, what rebates or fee structures these venues offer, and where the execution took place, said Samelson. Although larger buy-side firms have begun to extract a greater amount of data from brokers, many find it difficult to harness the data for real outcomes.

“Asset managers are getting better at asking brokers for execution data, but many still don’t have the time or resources for comprehensive analysis that would lead to changes to how they get brokers to execute on their behalf,” Samelson said.

Competing priorities

Although members of the buy-side may wish to see maker-taker tackled ahead of a holistic assessment of US market structure, the Commission has a number of competing priorities with which to deal and continues to cite the inter-linked nature of market structure issues as cause to address them in one review.

Such issues include addressing the rise in off-exchange trading, through mechanisms such as a trade-at rule; venue access fee rule reform; and greater regulation of high-frequency trading activity.

Sapient’s Myers notes the ongoing reforms triggered by the May 2010 flash crash, such as the introduction of the limit up-limit down mechanism and circuit breakers on lit venues, may also limit the SEC’s ability to address maker-taker outside of a holistic review.

“The flash crash reforms will be a higher priority for the SEC than maker-taker,” Myers adds. “So many exchanges engage in rebate programmes it would have a major impact of the Commission did remove maker-taker across the board, although it’s not completely inconceivable.”

In her speech, the SEC’s Stein reiterated the regulator’s commitment to helping market participants avoid system errors as the speed at which participants trade increases. She said avoiding events such as the flash crash and “mini crashes” that have caused significant price swings in large-cap stocks like Google and Walmart, was critical to maintaining strong capital markets.