Plans for an experiment to explore the impact of regulating trading venues’ fee structures are sparking joy with many market players, but are a source of alarm for others.
In late 2018, the Canadian Securities Administrators (CSA) unveiled plans for a pilot study to look at the effects of curbing trading fee/rebate structures. The planned study aims to address long-standing concerns among both regulators and certain market players about the possibly distorting effects of some of the fee structures used by various trading venues (in particular, the so-called “maker-taker” model).
Among other things, there is suspicion that these trading fee models may be harming market quality (and, ultimately, investors) by creating conflicts of interest in brokers’ routing decisions, thus contributing to market fragmentation, segmenting order flow and adding costly, unnecessary intermediation and market complexity.
To get to the bottom of whether these trading fee models are producing such effects, the proposed research aims to isolate the effects of trading rebates. To do that, a trio of academics has been hired by the CSA to design and carry out a test that would identify pairs of similar securities and prohibit markets from paying rebates on half of them.
This process will enable the researchers to compare the trading activity in stocks that pay rebates with those that don’t. The researchers also will evaluate the effects of these prevailing trading fee models on order routing, trade execution and market quality.
For many market participants (including both buy- and sell-side firms, and at least one trading venue), the regulators’ plans are being hailed as a welcome development.
“We believe this pilot is the most important market structure initiative undertaken by our regulators since the introduction of multiple marketplaces over a decade ago,” Scotia Capital Inc.‘s submission to the CSA states.
Submissions to the CSA from a variety of institutional investors, including a collection of major pension plans and several large asset managers, also are strongly in favour of the regulator’s initiative.
BlackRock Asset Management Canada Ltd.‘s submission, for example, states that the firm believes that “lowering fees and rebates would reduce their distortive effect on order routing, price transparency and market quality. Furthermore, this may mitigate fragmentation and ease burdens for investors by leading to a reduction in marketplace complexity.”
Scotia Capital’s submission notes that previous plans for a similar study were scrapped amid concerns about Canadian regulators undertaking this sort of experiment when so many Canadian stocks are interlisted in the U.S. This time around, however, the U.S. Securities and Exchange Commission (SEC) plans to conduct its own study, which would include interlisted Canadian stocks. Furthermore, regulators on both sides of the border are trying to co-ordinate their research. The CSA envisions running its study on interlisted stocks parallel with the SEC study, beginning its study on stocks that aren’t interlisted three to six months before the SEC pilot begins.
Scotia Capital’s submission insists the CSA should not back away from its plans. That submission states that the SEC’s participation “presents a unique opportunity to study, identify and measure the magnitude of these effects on the market for the purpose of guiding future policy choices. This is an opportunity that must not be passed up.”
This level of enthusiasm is not universal, however. Some market players are concerned about the impact that the CSA’s study could have on the trading environment and investors.
For example, CIBC Capital Markets Inc.‘s submission states that while the CSA’s research goals are noble, the firm is concerned that a real-world experiment could have a negative impact on retail investors by creating larger trading spreads and higher transaction costs for investors: “From the retail perspective, our primary concern with the pilot is the potential for a degradation in the quality of trade execution for our clients.”
Omega Securities Inc. (OSI), an alternative trading system, is even more critical of the CSA’s plans. That submission argues that the proposed experiment runs counter to the Ontario Securities Commission‘s (OSC) recent efforts to find ways to reduce regulatory burdens. Instead, the submission states, the pilot study will increase costs for market participants, broker-dealers and retail investors.
“We believe it is counterproductive to innovation in the marketplace to be embarking on a project that will create an increased burden,” OSI’s submission states. “We are supposed to be reducing undue burden and costs rather than compounding them.”
Moreover, OSI’s submission warns that the SEC’s plans face litigation in the U.S. from some of that country’s largest trading venues, which aim to put a stop to the SEC’s proposed study. And, OSI’s submission argues, the CSA should put its plans on hold until those U.S. lawsuits are resolved.
TD Securities Inc. (TDSI), however, which is a strong proponent of the CSA’s study, advises in the firm’s submission that the regulators shouldn’t be deterred by critics of the proposal. The submission notes that in the U.S., opponents of the SEC’s plan are primarily exchanges and market-makers that are keen to maintain the status quo because it suits their business. Institutional investors, which don’t have that sort of conflict, are almost all in favour of studying the impact of curbing rebates.
The TDSI’s submission states: “We hope that the CSA will see through commercial interests and move forward with its study on its own terms. “Fear-mongering that market quality will worsen for the zero rebate stocks is overblown.”
TDSI’s submission continues: “The views of the non-conflicted institutional investor community with agency best execution concerns needs to be considered first and foremost by Canadian regulators. This was the case with the SEC in the U.S. and should also be the case for the CSA in Canada.”
While supporters of the CSA’s plans are primarily institutional investors, there is one trading venue that’s in favour of the pilot study: Toronto’s Neo Exchange Inc. (NEO), which echoes many of the concerns with traditional trading fee/rebate structures.
NEO’s submission acknowledges that rebates create conflicts of interest, encourage intermediation and lead to added market complexity: “All of this has led to distortions in the Canadian market structure to the detriment of investors.” In addition, NEO’s submission states, markets and dealers that would prefer to operate differently can’t do so if they hope to remain competitive.
NEO’s submission states that markets would be better off without the influence of rebates. But it acknowledges that because rebates have been part of Canada’s market structure for such a long time, all of the possible consequences of eliminating them must be understood before regulators remove them.
NEO’s submission concludes: “In our view the proposed pilot represents a sensible next step.”