SEC’s transaction-fee pilot sparks lively debate
Issuers, investors and national stock exchanges are divided over the need for – and process behind the creation of – an SEC pilot scheme that would restrict the rebates on transaction fees that are paid to brokers and market-makers by stock exchanges.
The SEC voted in favor of the transaction-fee (also called access-fee) pilot – Rule 610T of Regulation NMS – in March 2018. The proposed trial would last for up to two years and is intended to gather data about the impact transaction fees and rebates have on order-routing behavior, execution quality and overall market quality. The SEC has received 82 comment letters since the open period for comments closed on May 12.
Proponents of the trial include notable pension funds and asset managers such as Vanguard, BlackRock, CalPERS, Wellington, RBC Capital Markets and T-Rowe Price, as well as IEX and the Securities Industry and Financial Markets Association. These institutions say a trial will gather enough data about whether the current system, where maker-takers receive a rebate from the stock exchanges for each transaction, contributes to market complexity or creates conflicts of interest.
The pilot will split companies into three different test groups, to which they will be confined for the duration of the trial. It applies to more than 3,000 companies and there is currently no opt-out or provision to leave the pilot. The groups are:
- Test group one: $0.0015 fee cap for removing and providing displayed liquidity, with no cap on rebates
- Test group two: $0.0005 fee cap for removing and providing displayed liquidity, with no cap on rebates
- Test group three: rebates and linked pricing are prohibited for removing and providing displayed and non-displayed liquidity.
Exchanges will be required to post monthly order-routing data and information about transaction fees and rebates on their websites during the pilot.
Critics of the pilot – which include Nasdaq, the NYSE, Procter & Gamble, Mastercard and the Security Traders Association of New York – suggest that placing issuers into fixed groups with different market conditions for a two-year term is risky.
‘Tearing our market apart, as this pilot is going to do, is like exploratory surgery for a cold,’ says Pat Healy, CEO of Issuer Network. He says the SEC should put together a panel of issuers to discuss the potential effects of the access-fee pilot and identify next steps.
Both Nasdaq and the NYSE say the pilot will be ineffective in gathering the data the SEC wants to obtain. They are concerned that by imposing fee caps, the SEC could drive trading activity away from the lit markets to dark pools, which account for up to 40 percent of the daily trading volume, according to the comment letters from both Nasdaq and the NYSE, and are not subject to the pilot.
The NYSE estimates the pilot would lead to widened spreads from brokers, which it says will harm liquidity of stocks and negatively impact investors’ execution quality, costing them up to $1 bn extra per year. But that hasn’t stopped publicly listed investors that would be subject to the pilot – such as BlackRock, State Street, T-Rowe Price and Vanguard – from backing it.
Allegations of fearmongering
The claim the pilot would hamper issuers’ liquidity and cost investors is disputed by IEX, which has accused the two large US stock exchanges of ‘fearmongering’. John Ramsay, chief market policy officer at IEX, says the responses from Nasdaq and the NYSE to the access-fee pilot are ‘fundamentally about protecting their revenue sources. If the rules are changed, they may have to adjust their business model and that may have an impact on their revenue, but that doesn’t mean it’s bad for issuers,’ he tells IR Magazine.
Hope Jarkowski, co-head of government affairs at Intercontinental Exchange, the NYSE’s parent company, doesn’t deny that the access-fee pilot will have an impact on the NYSE’s revenue, but asserts that the stock exchange’s primary motivation is to protect its issuers.
‘While there may be some effect from a revenue standpoint, we’re far more concerned about how it may affect issuers,’ Jarkowski says. ‘If you target how market-makers are compensated, the pilot, as envisioned, will likely drive order flow to non-transparent, unregulated, opaque dark trading venues. This will widen spreads and ultimately have a negative impact on listed companies. By design, this pilot is not studying the market impact of pricing and rebates because it is not evaluating the entire market. It’s just looking into exchanges, which are the most regulated, highly transparent players in our market.’
Concerns about due process
There are also concerns about how the pilot came to fruition. The current iteration of the pilot was created by the SEC’s Equity Market Structure Advisory Committee, a group that Healy points out had limited issuer input and no stock exchange input, following rounds of interviews and input from market participants. Brad Katsuyama, IEX’s CEO, was one of the 16 members of the committee, which was disbanded before IEX was approved as a listings venue.
NYSE's parent company ICE has previously expressed support for a fee cap, but takes issue with the current mechanics of the pilot. At the NIRI national conference last month, Stacey Cunningham, the new CEO of the NYSE, encouraged issuers to make their voices heard by writing comment letters to the SEC.
The NYSE has been briefing its listed companies and assisting them in writing letters to submit to the SEC, and Jarkowski says the number of letters from issuers is notable. So far 22 companies – including Procter & Gamble, MasterCard and The Home Depot – have written to the SEC expressing their concerns with the pilot or asking for their stock to be removed from it.
‘Public companies haven’t typically raised their voice on market structure issues because the system has been working well for them,’ Jarkowski says. ‘You’re more likely to find them raising their hand through a business group or trade organization. When they do put their name to a specific issue, as they are beginning to in this case, it’s because they’ve been made aware of a potentially serious issue and really care about the outcome.’
But in a second letter to the SEC, Ramsay accused the NYSE of going ‘to great lengths to mislead public companies into supporting its position, with misstatements and omissions of material facts, including the strong support of asset managers and pensions for the pilot.’
Editor's note: This article was updated on July 13 to clarify the role that the Equity Market Structure Advisory Committee played in creating the accesss fee pilot, as well as ICE's past stance on fee caps outside of the access fee pilot.