CBSX "Get Paid to Take" Model -- a Glimpse into the Future
23 August 2010 - TabbFORUM
Last Monday, the CBSX exchange inverted its traditional maker/taker pay model on 24 securities to offer a $0.0014 rebate to liquidity takers, while charging $0.0018 to providers. The majority of the exchanges charge takers of liquidity while giving rebates to providers. So why would the CBSX invert their pricing model?
It all has to do with attracting broker-dealer order flow. Many brokerages charge a flat commission rate to their customers, regardless of whether they provide or take liquidity. But the vast majority of retail investors are primarily takers of liquidity, many using market orders to enter or exit their trades. In these instances, the brokerage house could actually lose money on the trade. TD Ameritrade for example charges their customer $9.99 a trade regardless of size. So an investor placing a market order for 5000 shares is charged just $9.99. If TD Ameritrade routes this order to ARCA, they stand to lose money on the trade as the take fee would be $15.00. Therefore it is in TD Ameritrade's best interest to route this trade to other venues that do not charge these take fees.
There are a number of other options available to TD Ameritrade. They can internalize the order themselves, route the order to an OTC market maker, or route the order to a dark pool. In some cases OTC market makers, and other internalizing participants will actually pay TD Ameritrade for the order flow (called payment for order flow). A typical payment from an OTC market maker is $.0010. Therefore, on the 5000 share order TD Ameritrade gets an additional $5.00.
So doing the math, if they route the 5000 share market order to ARCA, they stand to lose $5.01 on their customer's order. If they route to an OTC market making paying $.0010 for the flow, they stand to make $14.99 on the order.
Therefore, there is little incentive for brokerages to route their customer's orders to the displayed market.
Now let's explore the new CBSX pricing model. If TD Ameritrade routes the 5000 share order to the CBSX (assuming the order was on one of the 24 securities in the new pricing model), they'll be paid $7.00. Now they stand to make $16.99 on the trade. All of a sudden CBSX is an attractive place for TD Ameritrade to route their orders too.
The other part of the equation is the SEC's concept of a "trade-at" rule. The SEC is concerned with the amount of order flow being routed away from the displayed market, as at a certain point in time it will start to affect price discovery. I discussed these concerns in my "Recipe for a Toxic Market" article.
With broker-dealer internalization approaching 30% of executed order flow, and dark pools executing an additional 10%, the SEC's concerns are well warranted. The problem is if they imposed a trade-at rule to increase flow to the "lit" markets, what do they do with the access fee problem? You can't force TD Ameritrade to lose money on its trades. One of two things has to happen. TD Ameritrade would have to raise commissions, or the exchanges would have to lower their access fees. But if the maker/taker model was inverted, access fees would no longer be a hurdle to impose a trade-at rule. The exchanges would welcome a type of trade-at rule as it would increase their market share.
As the exchanges lose more and more volume to venues that do not charge access fees, expect similar moves by the other exchanges in the future, especially if CBSX has some success in attracting more retail order flow.
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