Is that free trade actually free? Part II

This is part 2 in our series on market data fees which will further dissect the effect of data sourcing and real-time vs. delayed stock quotes. If you haven’t already, check out Part 1, which broke down Payment for Order Flow and the hidden fees and broker revenue streams coming from Alternative Trading Systems and how this unwittingly affects investors.

Real-time vs. delayed

Today, investors demand and deserve real-time data in order to have the information they need to take action. With the change in the trading landscape, new players in the space (e.g., BATs, IEX), the emergence of “dark pools” or Alternative Trading Systems (ATS firms) and the advent of media portal licenses for market data on finance sites, information is available to most of us in a split second from multiple sources. But that information, that data, needs to be transparent and reliable. Investors need to know — and are entitled to know — the source of the information they’re basing their investment decisions on.

With new technology comes new regulation

In 2005, the SEC issued the Regulation National Market System (Reg NMS) because they saw a need to strengthen the trading regulations around changing technology. Reg NMS contains four parts but the most relevant one is the Order Protection Rule, or trade through provision, which guarantees investors get the best price at the execution.

Previously, with trade throughs, an order could be carried out at a suboptimal price, even though a better price was available on the same exchange or another exchange. Now with RegNMS, trades must be conducted at the best price, no matter where that lowest price is available.

The complaint around this was that it forced traders to do business on a venue that was the cheapest but perhaps, in their estimation, not the most reliable or the fastest, in essence removing their choice of where to conduct trades. There was also a concern this would result in worse outcomes for institutional orders.

Here’s why this matters. All of the images below were captured within a 90-second window. Almost all are time-stamped and all but one (which explicits states it’s delayed data) claim to be real time. However, the price varies for each one and the time stamping varies, potentially due to the source not in fact being real time. So, if you’re making trades based on what you think are real-time quotes, are you in fact getting the most accurate data?  

Real time with a full timestamp, down to the second…though those timestamps vary despite being captured within the same 90-second window.  

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With just the date and no timing, it’s a little suspect…

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A full timestamp and a reference that the quote is delayed.

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The more you know

To the retail investor, Reg NMS ensures National Best Bid and Offer (NBBO) when they place a trade, providing an unambiguous benchmark for assessing execution quality. US  brokers pay a fixed fee to the exchange per user to access this real-time pricing data. “The data are priced so that individual investors pay very little and the professional investors who value the data the most and profit from it the most, pay for it the most.” Redistributors of the data also pay the exchanges to display that data on websites and apps.  

Further, Reg NMS mandates Vendor Display Rules whereby publishers, portals, app developers, etc., must display the source of their data and its timeliness, as we showed above. Keep in mind that the SIP feed with the NBBO is only required where the data is actionable, though many publishers will still present the NBBO to their users.  

The key, however, is that the investors need to know what the source of the data is…is this CBOE’s feed? Is it Nasdaq?  

SIP on this

Similar to our post about screenscrapers, we’re talking about transparency to the end user. In this case where they get their data, rather than where their data is being used.  

The issue with this according to James J. Angel, Ph.D., CFA, Associate Professor of Finance, Georgetown University, “there is not a good counterfactual for what the current U.S. market would look like without the SIP data.” From his studies of transparency, he found that without good quote and trade information, transactions costs for all investors would increase significantly (emphasis added).

What’s the price of doing business?

For NYSE- and NASDAQ-provided market data, all pricing is mandated by the SEC.  The pricing is publicly available on their sites. These fees break down based on professional vs. non-professional users with lower cost options such as Nasdaq Basic, or Nasdaq’s NLS. Fees can range from $50,000 to upwards of $100,000 per month for SIP feeds; while real-time feeds can also be accessed for non-professionals for as low as $0.25 to $10 per user per month. As an example, the CBOE1 feed — distributed by the CBOE — is an alternative for non-professionals, as it gives publishers a lower cost option for displaying real time, without trading.  

Recently, the SEC rejected fee increases requested by the NYSE and Nasdaq. Not because they were too high, but because they didn’t demonstrate that “these fees are fair and reasonable and not unreasonably discriminatory.” The striking down of these increases was done “to more efficiently and effectively ensure that market data fees are set, reviewed and regulated in the best interest of our markets and our Main Street investors,” according to a statement by SEC Chairman, Jay Clayton.

It’s time to pull back the curtain

The simple fact that investors, perhaps, aren’t getting the most recent information, or know the exact source of that information, does affect their pocketbooks. It just might not be with fees. Publishers need to disclose where the information they provide is coming from and the timeliness of the data, allowing investors to make an informed decision. Access to this market data is essential to America’s world-leading capital markets because all participants need timely and complete data to make informed decisions for all customers.”

Is that free trade actually free?

This is a 2-part post on market data fees, data sourcing and real-time vs. delayed stock quotes. In part 1, we’re going to break down Payment for Order Flow and the hidden fees and broker revenue streams coming from Alternative Trading Systems and how this unwittingly affects investors.  

From Rotary to Right Away (Sort of)

Gone are the days when grandpa would read the stock tables in the back of the Wall Street Journal and dial up his broker to place a trade. At the end of the last century, Yahoo! Finance pioneered providing the stock tables online with 15-minute delayed quotes. Since that time, there’s been considerable innovation in data delivery mechanisms and a massive influx of new competition changing the underlying economics, both of which have created derivative value being extracted in the form of Payment for Order Flow (PFOF.)

The 411 on PFOF

Let’s say Beth wants to buy or sell stock through her brokerage account. She places the trade online and assumes it goes by way of broker to the NYSE. However, because of PFOF, the trade is likely being processed through an electronic wholesale firm who pays her brokerage for the right to execute this trade on her behalf. These payments result in a conflict of interest between the firm and its client by incentivising the firm to execute its client orders with counterparties willing to pay the highest commission and so undermine the firm’s ability to act as a good agent.

As we see from the chart below, the wholesaler is deciding what’s best for the investor without asking them. And, while this practice has lowered trading costs for everyday investors, is it actually in their best interest?

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From two to 13…and counting

Market data is a $26Tr business, but until recently, there were two places executing almost 100% of trades – NYSE and NASDAQ. Today, they represent less than half of trades, with the remaining trading volume spread out across 13 other exchanges and 35-40 “dark pools” or Alternative Trading Systems (ATS firms). These ATS firms, such as Citadel, Two Sigma, Virtu and KCG Holdings, were created to let big investors swap large blocks of shares in secret, and have expanded to become a significant part of daily stock trading. In fact, more shares now change hands in dark pools than on the NYSE.

When No Fee is Really Lots of Revenue

Regulation NMS from the SEC requires that anyone working a trade, whether it be an exchange or a dark pool, must report trades back such that it’s included on the SIP quote feeds so this activity is captured in the National Best Bid and Offer (NBBO) presented to all investors. But there’s all kinds of revenue being made from this order flow. Last Fall, Robinhood was slammed in the market as 40% of their revenue came from order flow. During last year’s fourth quarter, regulatory disclosures indicated that they shipped virtually all of their orders for stock trades to four high-speed market makers. The bulk was bought by Citadel, which paid Robinhood an average of “less than $0.0024 per share” on the trades it was routed in that quarter. Those small numbers add up—Robinhood’s users have executed more than $150B in transactions.

As a FinTech unicorn that’s been positioned as anti-Wall St, this was a jarring exposure for many. Vlad Tenev, Robinhood’s CEO and Founder, went on the defensive in a letter to users, stating: “The revenue we receive from these rebates helps us cover the costs of operating our business and allows us to offer commission-free trading. Other brokerages earn rebates and charge you a per-trade commission fee.”

No one is saying that these companies don’t have a right to make money, however, in the age of “fake” news, investors deserve transparency around their information and their trades for the efficacy of their investment decisions. When they believe their trades are being executed a certain way and with their best interests at heart, but the truth is that may not be the case, the potential impact this could have on them can’t be underscored enough.    

In part two of this post we’ll dive into the importance of knowing where your market data and quotes comes from the effect of real-time vs. delayed quotes on trading decisions.