Much ado about nothing

Christian VoigtESMA is currently considering providing guidelines on fee structures. This sounds to me like the regulators are reviewing the maker-taker pricing model. MTFs introduced maker-taker pricing to Europe about four years ago, whereby liquidity providers receive a rebate for executing their passive orders, while liquidity takers will pay a fee for executing aggressive orders. Usually, the aggressive fee is larger than the passive rebate leaving the exchange with a net fee as a source of revenue.

The merits, or otherwise, of maker-taker pricing are the subject of much discussion. On the one hand, it is argued that this model is a major contributor to the success of BATS Chi-X Europe. On the other hand, it is said that maker-taker pricing is similar to payment for order flow and should be banned accordingly. The latest (questionable) mention is in the Ferber Report. Trading on exchanges with a maker-taker regime is one of the criteria that qualifies as a high-frequency trading strategy.

I personally believe that maker-taker pricing is neither beneficial nor dangerous to market quality or liquidity and I don’t think the success of Chi-X can be attributed to its use,  beyond the fact that it was significantly cheaper compared to any other incumbent exchange. In Europe, it has no real impact because any incentive to provide more liquidity is compensated for by changes in the spread. It is much ado about nothing!

Take a look at these slides for a detailed explanation.

ESMA may well be right to look at maker-taker pricing given that it does not support market quality and liquidity and it’s possible that some brokers may be incentivised to maximise fees at the expense of their clients.  However, in the grand schemes of things, the potentially negative effects are quiet small. Chi-X offers a 0.2bps rebate (maker) and a 0.3bps fee (taker), while the average spread of Vodafone is around 3bps.  Any distortion will be marginal compared to the implicit trading costs paid by investors.

Will ESMA choose the easy route like their US colleagues and impose a maximum taker fee to limit excessive distortions (see RegNMS rule 610(c))? As with all easy solutions, they can come back to haunt you, as seen in the recently re-ignited maker-taker discussion in the US.

2 Responses to “Much ado about nothing”
  1. Anonymous says:

    I think a significant area that has been overlooked here is the impact to the listed derivatives market.
    Even after persistent lobbying by derivatives industry participants and trade organisations the directive below remains in both draft versions of the amendments as well as in non-papers.
    “Trading venues to ensure fee structures contain higher fees for placing an order which is cancelled than for an order which is executed and higher fees for markets participants who place a high ratio of cancelled orders.”
    It is difficult to understand how this could be successfully applied to derivatives markets. With the lot size of a particular order being relatively low when compared to equities and the pricing model from brokers and exchanges being per lot then the implied requirement that order fees and cancellation fees will be introducing would be a massive industry challenge. Significant changes would be required at exchanges with new billing processes introduced. Then there is the knock-on impact to brokerage agreements for give-ups where supposedly the clearing broker would need to collect cancellation fees from the executing broker.
    The net result would be a significant withdrawal of liquidity, much wider spreads and more fees for the client who will ultimately bear the cost of cancelling an order (for good reason if the market moves the opposite way to which they expect) as well as the cost of all the new market infrastructure required to collect and invoice these fees.
    Transaction ratio penalties are an industry solution to excessive messaging but the regulators seem to have their fingers in their ears.

  2. Christian Voigt says:

    Apart from the maker/taker model, there is the whole issue of order cancellation fees as suggested in the Ferber report on MiFID (amendment 12, Recital 48a) I share your concerns, on the potential implications.
    However, before considering all the possible issues, I want to question the motivation of mandating cancellation fees at all. In my view, regulators should foster competition and intervene when market failures occur. In terms of order cancellations, I do not see it.
    Firstly, MiFID I introduced competition to the equity space. Furthermore, there are numerous new ventures under preparation to bring an increased level of competition to the derivatives markets, once MIFID II and EMIR are implemented.
    Secondly, there are already exchanges that charge or have charged some form of order cancellation fee. ( This is an ideal example of how competition works. Exchanges try to develop the best possible fee model to create a highly efficient market and attract customers. Obviously, there are many subtle factors to take into account. Therefore, some exchanges introduced some form of order cancellation fee, while others abandon it. This all relates to the considerable knock on effects on different areas.
    To sum up, I cannot see any sign of market failure. Markets work fine as they are. Thus, regulators forcefully mandating changes has little upside and massive downside potential.

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