If this is a catalyst - then it's a good thing IMHO. Home » Story Tim Cave TABB Group Follow | Profile More From Tim Cave Related 19 October 2018Exchange Governance and Market Structure: Jim Toes, STA Maker-Taker Malaise: LSE’s Turquoise Bins Broker Rebates The focus on exchange rebates moved from the US to Europe this month, as equity venue Turquoise announced plans to abolish certain rebates on its lit book. TABB’s Tim Cave examines the maker-taker controversy as efforts to re-tilt the market structure playing field back in favour of investors gather steam globally and breaks down the drivers and implications of Turquoise’s decision. The focus on exchange rebates moved from the US to Europe this month, as efforts to re-tilt the market structure playing field back in favour of investors gather steam globally. Turquoise – the equity trading venue majority-owned by the London Stock Exchange Group – announced plans to abolish certain rebates on its lit book (excluding its periodic auction) from November 1. Brokers handling client orders will no longer be eligible for rebates, though they will still be on offer to proprietary trading firms (see Exhibit 1, below). Exhibit 1: Fee Structure on Turquoise Lit Book Note: LPS refers to firms that are part of Turquoise’s Liquidity Provision Scheme Source: Turquoise Rebates are part of the so-called “maker-taker” fee model that has been the predominant pricing mechanism on major US equity markets for some time. It was adopted by many of the new venues established in Europe after MiFID I in 2007 – including Chi-X Europe, Bats Europe (now merged under Cboe Europe) and Turquoise – as they sought to build market share to compete with incumbent exchanges. Under the model, exchanges pay participants a per-share rebate to provide, or “make,” liquidity, while charging the other side of the trade a fee to remove, or “take,” liquidity. The rebates are designed to incentivise firms to provide prices – facilitating more buying and selling activity in general – with exchanges picking up the net difference as revenue. Critics argue the model creates conflicts of interest, if broker-dealers send orders to venues to pick up rebates rather than to secure the best execution for their end clients. While outliers remain, most brokers say they have dropped rebates as a factor from order routing methodology. Nevertheless, scrutiny on the issue has intensified this year. The US Securities and Exchange Commission in March proposed a two-year transaction fee pilot scheme limiting payments for up to 3,000 stocks, to assess the impact of rebates on order routing behaviour and execution quality. [Related: “Can the Markets Function Without Maker-Taker?”] In Europe, tougher best execution rules under MiFID II mean there is a stronger onus on brokers to secure the best price for end investors. The new rulebook also requires brokers to disclose how much they pick up in rebates, as well as any ownership stakes they have in venues (a group of 12 banks collectively own 49% of Turquoise). However, there is not an explicit regulatory driver for Turquoise’s move, akin to the fee pilot in the US – and the EU market structure does not require a focus on price quite as much as in the US. In fact, the European Securities and Markets Authority (ESMA) clarified in a recent update to one of its MiFID II Q&As that rebates were still permissible if they are tied to a liquidity provision scheme. What this move suggests is that Turquoise is keen to remove any perceived conflict of interest, take an ethical stance and react to the current rhetoric around improving markets for end investors’ benefit. This debate started in part following the publication of Michael Lewis’s “Flash Boys” and has grown following some high-profile fines for the broker community, all serving to intensify focus on order routing behaviour. It is worth noting the strong buy-side support of the SEC’s proposed fee pilot. In June, T. Rowe Price wrote in an SEC letter that it had “long been an advocate for changes to the maker-taker model because we believe that the avoidance of access fees generates an inherent conflict of interest for brokers, while rebates create unnecessary market complexity and fragmentation.” Other factors playing into Turquoise’s decision could be the competitive forces it has faced under MiFID II, from venues new and old. Turquoise competes most directly with Cboe Europe and Aquis Exchange – lit venues that trade stocks from across Europe and to which Turquoise has steadily lost market share over the past year (see Exhibit 2, below). Exhibit 2: Market Share of Major pan-European Lit Order books Source: big xyt Cboe has the benefit of being able to run multiple lit order books with different fee structures (see Exhibit 3, below). Only its CXE lit order book – which is the legacy Chi-X Europe platform – continues to offer rebates, while its BXE lit book, the legacy Bats venue, has run without a rebate since January 2013. Aquis does not offer rebates, having chosen a pay-as-you-go monthly subscription fee model instead. Exhibit 3: Fee Structures on Cboe Europe Lit Books Source: Cboe Europe As the fees in Exhibits 2 and 3 show, Turquoise has run a more aggressive rebate than CXE for a few years. It probably wanted to bring its fees in line with others and, rather than just trim around the edges, it has clearly taken the opportunity to make a bold move as well. So what might the effect be? It’s important to stress Turquoise is not dropping rebates completely – they still are available for proprietary trading firms (albeit at a lower level), which generally account for the bulk of these payments. If brokers stop sending orders to collect rebates and focus instead on best execution, this should improve the overall quality of the market. A more simplified fee structure also levels the playing field for everyone’s benefit. A concern is that brokers may make up for the lost rebate by widening spreads, which investors may end up paying for. However, it is worth noting that Turquoise has also significantly dropped its “taker” fees during this change, which results in little net-net change for some firms. It will be interesting to watch the impact this change has on Turquoise’s execution quality.