Stock exchange transaction fee pricing, including maker-taker and taker-maker fee-and-rebate pricing models, impact on order routing behavior, execution quality, and linked pricing for removing & providing displayed & undisplayed liquidity. Say what?
Despite the jargon, the upshot is that the SEC is running a pilot study with a control group and three test groups to investigate whether certain transaction fees and rebates – largely to brokers from stock exchanges for routing transactions in a particular fashion – are leading to higher than optimal costs for investors.
Two of the test groups place very small caps on fees; the first is a $0.0015 fee cap and the second a $0.0005 cap. In the third test group, fees are prohibited. The pilot study will run for two years, though there is an automatic sunset after one year
I spoke to the Council of Institutional Investors’ General Counsel, Jeff Mahoney, to unpack what the SEC was attempting to find out.
“The CII has a long-standing policy that is cited on the first and second pages of our May comment letter, related to trading practices,” said Mahoney. The CII’s was one of the earliest letters posted on the study.
More recently, the Principles for Responsible Investment (PRI) has written in support of the study and the CII’s earlier comments. “That membership-approved policy,” continued Mahoney, “identifies concerns about the brokerage industry practices that may be antithetical to the fiduciary obligation of obtaining best execution. The proposed SEC Transaction Fee Pilot appears to be ‘on all fours’ with that policy. As described by the SEC, the purpose of the pilot is to shed light on the extent, if any, to which broker-dealers route orders in ways that benefit the broker-dealers but may not be optimal for customers, i.e. our members.”The CII also confirmed its support of two features of the pilot’s design: test group 3, the one that prohibits rebates, and the fact that companies cannot opt out of the pilot. “We agree it is critical that the pilot include ‘test group 3’,” said Mahoney, “in which equity exchanges generally would be prohibited from offering rebates to broker dealers. We believe this ‘no-rebate bucket’ would allow the Commission to more directly study the conflicts that rebates create and their effects on execution quality.”
Of the inability of companies to opt out, Mahoney said: “We agree that issuers should not be allowed to opt out of the pilot. We believe the usefulness of the data to be collected from the pilot and the related analyses that follow could be negatively impacted, if for example, large numbers of issuers of lower-priced and small-cap stocks were to opt out.”
The study has not been without its critics, however. “We also wrote to a number of New York Stock Exchange listed companies on July 20,” said Mahoney, “in response to reports in the press that the NYSE was requesting its members to write comment letters opposing the pilot. Those letters explained our support for the pilot and requested that the letter be shared with the company’s full board.”
It should be remembered, of course, that this is a study, not a statement of an intent to undertake any rulemaking in the area. Since even the study is controversial, it is likely that any rulemaking that might ensue will also be controversial. Most of the investor comment letters I reviewed were in favour of the pilot, though there have been some concerns raised by issuers.