Nasdaq & Cboe question SEC’s legal authority on rebate proposal

Debate over controversial maker-taker pricing continues in the US as comment letters are published on regulator’s proposed transaction fee pilot.

Major US exchange operators Nasdaq and Cboe Global Markets have challenged the US financial authority’s proposed changes to fee-and-rebate pricing models for stock exchanges.

Both Nasdaq and Cboe have questioned the Securities and Exchange Commission’s (SEC) legal authority to enforce the proposed changes, known as the transaction fee pilot.

The pilot would see major restrictions to pricing across stock exchanges for maker-taker pricing, which typically provides a rebate to traders adding liquidity to an order book, with an access fee then charged when liquidity is removed.

Nasdaq said the proposal imposes “impermissible government rate-making”, urging the SEC to consider alternatives that impose lower costs and risks on the market, and are less damaging to competition.

“Government rate-making is a discredited vestige of intrusive, Depression-era legislation. Courts and policy makers broadly understood that rate-making reduces competition, increases inefficiency and costs, and harms consumers,” Nasdaq wrote in its comment letter on the access fee pilot.

Cboe Global Markets’  letter echoed Nasdaq’s, stating the SEC’s proposal “misses the mark” as the Commission failed to carry out a true review of the equities market.

“Cboe has considerable reservations about the price control pilot, including that the proposal is attempting to address a problem that has not been meaningfully identified or articulated,” the exchange wrote. “Cboe also respectfully questions the Commission’s logic and legal authority to impose federal price controls as proposed.”

Subject of controversy

Controversy has raged around the subject in the US, as many traders believe brokers route orders based on where they can get the highest rebate, rather than where they can get best execution.

A report authored by Greenwich Associates last year found that 65% of buy-side equity traders agree that the maker-taker method can create pricing distortion and is generally bad for market structure.

Asset managers, including BlackRock and Invesco, expressed strong support for the access fee pilot in recently published comment letters. BlackRock stated that “lowering access fees and rebates would reduce their distortive effect on order routing, price transparency, and market quality”.

Similarly, Invesco wrote that the pilot would see new data obtained that will allow the Commission to identify conflicts of interest and imbalances in the current market structure.

“[Invesco] has long believed that the maker-taker pricing model may create unnecessary complexity in the market, reduce market transparency and, in certain instances, create incentives for brokers to route orders based upon the levels of access fees charged or rebates to be received, rather than in a manner that is consistent with best execution.”

However, Goldman Sachs and Virtu Financial also urged the SEC to rethink the proposed pilot and questioned the need for it. Goldman Sachs described the proposal as “lengthy, complex and costly”, instead suggesting the SEC reduce the Fee Cap as a reasonable alternative.

Similarly, Virtu Financial’s chief executive, Doug Cifu, expressed major concerns with the proposal, stating another industry pilot is not the way to address perceived conflicts.

“There is a view among some market participants that exchange rebates are either unfair or create irreconcilable conflicts in order routing behaviour. We do not hold that opinion,” Cifu said. “If the Commission decides to proceed with the pilot, we recommend that it be narrowly tailored to create the least amount of disruption to the market.”