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Animal Farm And Market Data: Negotiate To Be ‘More Equal’, By Kelvin To, Founder And President Of Data Boiler Technologies

Date 18/06/2019


Animal Farm by George Orwell is one of the 100 best English-language novels since 1945. It tells a satirical tale about “all animals are equal, but some animals are more equal than others”. Taking the book’s analogy and consider the situation of all market participants contributed to the Exchanges’ order books. Who owns the data, should and how they will be compensated when aggregators sell market data? According to IEX’s disclosed cost of offering market data and connectivity, the technology cost (data aggregation and possibly inclusion of an imbalance or other calculations) is minimal. NASDAQ’s counter respond suggests that ‘Free’ (market data service) may not necessary be fair to all.

Reference to the SEC’s market data roundtable in Oct, 2018, Virtu’s CEO said, “The Exchanges charge my firm a total of $1.188 million per year each and every year for six cross-connects. A cross-connect is simply a cable that plugs into an exchange. This is literally the cable that they use… It is 328 feet of wire … found the exact same spool cheaper on Amazon for $88.” His statement got many to chuckle, while NYSE, NASDAQ, and CBOE Global Markets are more serious in defending their position, which can be summarized in two points:

(1) intense market competition since NMS implementation, therefore direct technology cost does not reflect their full cost;

(2) only a small portion of their customers subscribed to the low-latency proprietary feeds, hence not everyone needs the ultra-low latency services and/or the full-depth of books.

The Exchanges’ first argument simply describes the objective of NMS, i.e. to foster competition. So, I don’t quite follow what they are trying to suggest, except feeling mercy amid battles among Exchanges as well as with other trade platforms.  The second point is indeed an interesting one. Buy side firms, such as T Rowe Price, vigorously argued that they need the full depth of book and the ultra-low latency market data feeds in order to compete and provide best execution/ order protection for their clients. This is similar to the proliferation of approaches to redirect/ attract order flow (both legitimately and via alleged exploitations) by Exchanges, Dark Pools, and Systematic Internalizers. At the end of day, which firms truly represent the institutional community, the retail, and/or the long-term interest of main street investors? Truths may only be found after market crisis; or there may be no good or bad guys, just people jockey around trying to make money.

So, is the fairness issue on market data a moot point? My answer is NO. According to an empirical research by Giovanni Cespay and Thierry Foucault, “a for-profit exchange optimally restricts access to price information”. In other words, NYSE, NASDAQ, and CBOE may make a deliberate choice to selectively price-out who may or may not have access to their ultra-low latency speeded market data feeds in order to maximize their profits. So, this is not a matter of choice by data subscribers, but the availability of real-time full depth data is supply driven. The research further shows that “pricing errors and thereby speculators’ trading profits decline when price information becomes available in real-time to a wider number of speculators”. This matches perfectly with the recent market observation – many fled the markets citing high market data cost and losses, including proprietary trading firm Ketchum, hedge fund Tourbillion, etc.

The harsh reality is: a group of elite firms (e.g. MEMX core members) able to negotiate with the Exchanges for order flow they contributed and got some ‘premium rebates’ in return (e.g. the ‘super tier’ 32 mils rebates). Unfortunately, others who also contributed do not get the same rewards. Consequently, the big get bigger. The market is further divided into fragments amid information advantage for subscribers of direct feeds over SIP’s core data, alleged price discrimination on market data, and rebate distortion. This is highly unhealthy as the markets may ultimately become a landfill, dumping ground if without speculators trying to pick out hidden gems. I am not against securitization and off-loading of risky assets that do not fit particular institutions’ appetite. Instead my emphasis is: one person’s trash can be another person’s treasures; the capital markets need diversified players in order to improve price discovery and sustain ongoing development!

Obviously, MEMX core members despise any market data cost burden and the SEC’s access fee pilot can squeeze into their profits. One way to diminish effect of the pilot is by exacerbating market data price differences to keep the constituents happy. However, the SEC has recently told the Exchanges to better justify their fees and can decline any propose price changes. Alternatively, MEMX can declare dividends to its owners substituting the fee rebates they currently received from the big Exchanges. This essentially causes the access fee pilot to become ineffective by merely declaring an intention to form MEMX. Not only would this ensure “more rights” are always enjoyed by MEMX core members, it is also an offensive strategy against the big Exchanges. If the NYSE, NASDAQ, and CBOE want to avoid new competition, they better hope their lawsuits would result in ceasing of the access fee pilot. Depending on the litigation outcomes, the big Exchanges may give some concessions to negotiate/ convince the new Exchanges not to establish, or MEMX may go to Europe markets instead. Therefore, MEMX core members don’t necessary need to part ways with the big Exchanges because vested interests are already well protected.

In the next article, I’ll strategize the best possible defensive / offensive moves by different constituents in this ‘Warring States Period’, so stay tuned.