As any reputable online trading broker would agree, the Maker-Taker pricing model can distort the market and alter the way market participants transact stock orders. Maker-Taker refers to a pricing model that exists in most exchanges, to encourage stock liquidity in their venue.
Most exchanges, (not all, and not all are the same), will give a small rebate to investors and traders upon execution of their limit order, as they are providing liquidity to the market, the maker part of Maker-Taker. These liquidity rebates are what drive the Maker-Taker model.
Conversely, exchanges charge a modest fee to the market takers, those that enter market orders or marketable limit orders, thus taking liquidity. This issue of Maker-Taker is a hot topic among traders and online trading brokers. Many oppose the practice as brokers can use the exchanges that give the most advantageous rebates, instead of committing to the best execution, thus creating a conflict of interest.
The rebate reward system contributes to the already predatory environment swarming with high frequency trading algorithms, overtaking online equity trading in all venues widespread across the market. High frequency trading (HFT) firms use very specific sophisticated algorithms designed to seize as many liquidity rebates as they can, regardless of the impact this may have on the market and the National Best Bid Offer (NBBO).
Maker-Taker Affects Price Discovery
Online trading broker firms have long been calling for an end to the Maker-Taker system, as it most certainly does influence order-routing decisions, as well as distorting price discovery. With different exchanges having different fee schedules, brokers have incentive to route their orders so that it is most advantageous to them, rather than giving their client ‘best execution’.
An example of the Maker-Taker model is when an exchange will pay a market maker .002 per share to provide liquidity, and will charge the market taker .003 per share to take it, leaving the exchange to keep .001. Even though the rebates given to market makers are very small, they add up significantly with millions of shares traded on a daily basis by HFT firms. These small rebates add up to billions of dollars in the pocket of HFT firms simply by utilizing computerized algorithms based on their designed trading strategies to elicit the most rebates.
The exchanges use maker-taker as marketing, drawing executions to their marketplace. If you can lure liquidity-adding orders with big rebates for that liquidity, the other side of the trade has to come to you, which increases volume, and profits, for the exchange. Of course, the opposite is also true – those taking liquidity have price sensitivity also, and will try to go to the exchange with the lowest cost to remove liquidity. This is why we have seen nearly all exchanges create separate exchanges that differ only in the pricing model. Nasdaq owns PSX and BSX exchanges, which have “inverted” pricing models that pay rebates to remove liquidity, while those adding liquidity pay small fees. EDGE does the same with EDGA, BATS the same with BATY.
Those that oppose the Maker-Taker system believe that the public view of the current bid/offer price is not accurate due to the rebates and discounts. HFT firms will buy and sell at the same price, just to exploit the rebates. This activity can mask the true price discovery of stock assets.
When HFT firms are already at an advantage with high speed data cables, co-located equipment and paying for premium data flow, adding the rebates available under Maker-Taker pricing model gives most HFT firms an incentive too great to refuse, regardless of how it affects the market.
Order Types and Maker-Taker
Each exchange has their own order types, with unique fees associated to those specific order types. Nasdaq recently developed a Retail Post Only Order, which was designed solely to aid retail brokers in avoiding or reducing access fees. This particular order would have allowed for it to cancel for any reason, rather that fill with an adjusted price. For instance, if a retail broker receives your order to buy at 10.25, and the market is 10.25×10.26, they send it to the exchange to add liquidity (and earn a rebate). Now suppose just as it sends the order, the market changes to 10.24×10.25. Your order just became marketable, and instead of earning a rebate for adding liquidity, your broker will now have to pay to remove liquidity! The Retail Post Only Order protects them by canceling the order if it becomes marketable and would remove liquidity. That order would then likely be re-routed back to the third party that pays for the broker’s order flow to be filled, rather than to the exchange.
Proponents argue that this choice is good for competition, the exchanges offering them view this competition as good for markets. Opposition to these types of orders points out that these one- sided order types benefit only the select few and distort market pricing, which is never good for investors.
Under much scrutiny, Nasdaq withdrew their request for this order type in January of this year.
Add-Liquidity Orders (ALO)
An ALO order, or Add Liquidity Only order, is executed only if it adds liquidity as a market maker. The goal behind these order types is once again to assist the user in controlling their costs, and reducing fees.
They are used, however, to game the system, as entering a marketable ALO order forces the other side, which should have gotten a liquidity rebate, to now be a Taker and incur a cost. This happens with non-display orders that fall between the NBBO. If the market is at 10.14×10.16, and I have a hidden order to sell at 10.15 on ARCA, if an ALO order comes in to buy at 10.15, I would become the taker, even though I was there first. If my order was visible (NBBO at 10.14×10.15), the ALO order wouldn’t cross at all, it would just sit on that bid at 10.14, meaning a trade that would otherwise occur and aid price discovery doesn’t happen simply due to the maker-taker pricing model.
IEX Flat Rate Fee Schedule
IEX, the newest stock exchange, has no connectivity or data fees, and they do not encourage a Maker-Taker environment; rather, they implement flat rate fees based on order visibility. For example, for non-displayed liquidity, brokers pay a flat rate of $.0009/share whether they are making or taking liquidity. For displayed liquidity, there is NO fee whether making or taking liquidity. Here, the choice for the customer is whether to take the discount for making their order visible, and thus part of the NBBO, or pay extra to hide it.
The flat fee schedule utilized by IEX puts the incentive where it should be, on displaying your liquidity and aiding price discovery in the market.
Maker Taker Pilot
There was talk of a pilot program to measure the impact that reduced fees would have on market behavior, and quality. The Securities and Exchange Commission’s Equity Market Structure Advisory Committee recommended the pilot program last year. Then SEC Chairwoman Mary Jo White stated that the pilot would be voted on by the commission in 2017. Since then, new developments such President Trump in the White House and turnover at the SEC have put the pilot on hold.
Mary Jo White resigned as SEC Chair prior to Trump’s inauguration, and according to Trump’s advisors, incoming SEC officials are looking at broader reform, rather than piecemeal reform with Maker-Taker. Paul Atkins is the former SEC commissioner, who now advises President Trump on financial regulation matters. Mr. Atkins is actually an opponent of Reg NMS, and a proponent for a holistic overall review of the market.
It will be interesting to see what the new administration, and new SEC leaders call for in the coming months. While exchanges provide a valuable service, and need compensation, a flat fee would still result in revenue for the exchange, without creating a conflict of interest.
There is no easy answer for such a complex situation. The majority of traders, online trading brokers and investors agree, however, that Maker-Taker needs to go! (and we don’t need a pilot program to tell us that).
Great Point Capital has the in-depth knowledge of the market structure and order types, including the available order types to go directly to dark pools, to place orders at the midpoint of the NBBO, or capture rebates by adding liquidity. We combine this knowledge with valuable tools like the Takion software platform, to let you direct orders to the venue giving the best outcome.
Great Point Capital has been serving the trading community since 2001 and our 100+ prop traders actively trade the firm’s capital, specializing in equities and equity options. We are headquartered in Chicago with a location in Austin, TX. Contact Great Point Capital LLC today, in either our Chicago Office, or our Austin Office, to learn more about how we can successfully trade together with high performance results. We are one of the very few firms able to offer access to Takion Software Platform, enhancing your online trading broker performance.