Global exchange operator NYSE Euronext has struck a raw industry nerve with its recently approved Retail Liquidity Program that is set to start its 12-month run on 1 August, if the volume and tone of comment letters on the pilot filed with the US Securities and Exchange Commission (SEC) are a proper gauge of concern.
Of the 33 comment letters from private investors, broker-dealers, asset managers, industry associations and academics, each cites the potential danger of the initiative to the existing US equities market structure.
The pilot’s goal, according to NYSE Euronext filings, is to gain additional retail order flow by providing better price improvement than the national best bid and offer (NBBO) for retail orders submitted by exchange-approved retail member organisations (RMOs). This liquidity would interact with non-displayed retail price improvement (RPI) orders provided by retail liquidity providers (RLPs) that would be better than current NBBO prices.
In turn, NYSE Euronext would charge RLPs and any other firm submitting RPI orders while crediting RMOs for their retail order flow.
However, some industry members, including Leonard Amoruso, general counsel for the Knight Capital Group, feel the new service could have unwelcome unintended consequences.
“Several SEC-approved rules, as well as several pending regulations and industry practices, are directly impacted by the proposed program,” he stated in his comment letter dated 7 March, 2012. “Accordingly, the potential for unintended consequences is substantial.” Among the issues of which the pilot may knock-on effects Amoruso cites the impact on overall NBBO transparency and quotation minimum price variants.
In the US equity markets, a large proportion of retail order flow has been captured by the electronic market making arms of Citi, Citadel, Knight and UBS, who promise to beat the NBBO for retail brokerage customers via internalization.
For market watchers, the pilot is a simple method to capture market share in a down market.
“One of the best ways to win back market share back from the over-the-counter (OTC) market is through regulatory intervention,” says Adam Sussman, principal and director of research of industry analyst firm TABB Group. “This is one feather in NYSE Euronext's cap for that.”
According to recent TABB Group research, retail orders represent 14.5% of the total US equities share volume currently, while institutional and hedge fund order flow represents 28.5% of the share volume. The rest, says comes from high-frequency traders and bank flow.
Sussman views NYSE Euronext’s pilot as the latest way for an exchange to inject itself into the trade internalization process between retail and wholesale brokers.
“When Direct Edge had flash orders, TD Ameritrade routed a large amount of its volume to Direct Edge, where the internalizers competed for the flow through the flash mechanism. That is what NYSE Euronext is hoping for,” explains Sussman. “The [RLP] process is different, but the flash orders was in internalization mechanism within an exchange.”
Nothing to lose
Considering the amount of time and resources necessary to create and deploy the Retail Liquidity Program, NYSE Euronext – and other exchanges – have nothing to lose, says Sang Lee, managing partner at industry research firm Aite.
“If they succeed, they capture a very interesting part of the market on the retail side, which should be good for their institutional clients, who are looking for good quality order flow into the public markets. Maybe this will help them increase the overall volume in the overall marketplace, which would be a net positive for everyone. If they fail, nothing changes really,” he adds.
NYSE Euronext’s latest quarterly earnings filing with the SEC, which covers the first quarter of 2012, provides the exchange operator with a major incentive to attract new liquidity. It reported a US$206 million fall in transaction and clearing fees, a US$5 million drop in market data revenues and a US$105 million downturn in liquidity payments, routing and clearing revenue over the same period in 2011.
However, Lee predicts that it will not be smooth sailing for pilot. “Whenever someone questions the status quo, those firms that have vested interests in the current market structure are going to react and it won’t be positively,” he says.
TABB Group’s Sussman believes that that institutional investors may also have a seat at the retail table depending how the wholesale brokers-dealers react to the pilot. If they can route institutional order flow through their retail broker-dealer licences, of which the larger firms have many, and provide institutional investors with the proper trading algorithms, the institutional flow might wind up providing liquidity to the retail flow.
From a much wider perspective, Sussman view NYSE Europe’s retail gambit as just one more move on the market structure chessboard.
“This is a beginning of changes that will occur to US equities market structure that will happen over the next 15 months,” he explains. “We’ll see other exchanges come out with other competing proposals and see internalizers change the way they do business as a reaction to this. We’ll see the institutional order flow interact with this change. We’ll see additional proposals come out pushing the market in different direction.”