Exchanges and some high-frequency traders are under scrutiny of rebate pricing systems that regulators believe will distort pricing, reduce liquidity, and cost long-term investors.
The so-called maker-taker fee provides liquidity providers (market makers) with transaction rebates, and at the same time charges fees to customers who accept the liquidity. The main purpose of Maker-Taker fees is to stimulate trading activities within the exchange by providing companies with incentives to issue orders, and theoretically promote transactions.
- Maker-taker fees, also known as order flow payments, provide liquidity providers with rebates for participating in the market.
- Makers are market makers that provide a two-way market, and takers are people who trade at prices set by market makers.
- The MKR-Taker system was established in the 1990s and early 2000s and became popular with the advent of algorithms and high frequency trading (HFT).
Maker and receiver
Manufacturers are usually high-frequency trading companies, and their business model depends to a large extent on specialized trading strategies aimed at obtaining payment. The recipient is usually either a large investment company looking to buy or sell a large number of stocks, or a hedge fund betting on short-term price movements.
The Maker-Taker model runs counter to the traditional “customer first” design. Under this design, customer accounts receive order priority without having to pay exchange transaction fees. Under the customer priority model, the exchange charges market maker fees for transactions and charges fees for order flow. The order flow payment is then remitted to the brokerage company to attract the order to a given exchange.
The Maker-Taker program dates back to 1997, when Joshua Levine, the creator of Island Electronic Communications Network, designed a pricing model to incentivize suppliers to trade in markets with small spreads. In this case, the maker will receive a rebate of $0.002 per share, and the recipient will pay a fee of $0.003 per share, and the exchange will keep the difference. By the mid-2000s, the rebate capture strategy had become the main content of the market’s incentive function, and the reward for every 100 shares traded was 20 to 30 cents.
Exchanges that adopt the maker-taker pricing plan include NYSE Euronext’s Arca Options platform and Nasdaq Inc.’s NOM platform, and the US options exchange launched by BATS Global Markets. Both International Securities Exchange Holdings, Inc. and the Chicago Board Options Exchange under CBOE Holdings, Inc. use the customer priority system.
Possible pricing distortion
Critics of this approach believe that due to rebates and other discounts, the public buying/selling prices in the market have become inaccurate. Some opponents point out that high-frequency traders use rebates to profit from the spread between rebates by buying and selling stocks at the same price, which obscures the true price discovery of assets. Others believe that manufacturer-taker payments create false liquidity by attracting people who are only interested in rebates and who do not trade stocks in large quantities.
Research by Shane Corwin and Robert Battalio, professors of finance at the University of Notre Dame, and Robert Jennings, a professor at Indiana University, found that stockbrokers regularly direct customer orders to the market that provides the best payment, which produces more results than if the broker did not consider payment. Bad.
More careful supervision
In January 2014, Jeffrey Sprecher, CEO of Intercontinental Exchange (ICE) Group, Inc., which owns the New York Stock Exchange, called on the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) ) And other regulatory agencies investigate in-depth understanding of rebate pricing practices. In a letter to the U.S. Securities and Exchange Commission, Royal Bank of Canada’s Capital Markets Group claimed that the manufacturer’s taker’s arrangement encouraged conflicts of interest and should probably be banned. After a strong protest, Senator Charles Schumer (D.-NY) asked the US Securities and Exchange Commission to study this issue.
In a speech on April 2, 2014, SEC Commissioner Louis Aguilar announced that the SEC is considering a test plan to reduce manufacturer-recipient rebates through a pilot program , The plan will waive the manufacturer-acceptor fees for selected stock groups during the trial period to demonstrate how the trading of these securities will be compared with the corresponding stocks of the reserved manufacturer-acceptor payment system.
Although the use of the Maker-Taker fee system has increased since the late 1990s, the future of the Maker-Taker fee system is still due to calls for regulatory review of pricing models by academics, financial institutions, and politicians. uncertain.