March 3, 2011
Nasdaq's proposal to penalize member firms' use of multiple MPIDs should be rejected. It will decrease transparency, increase risk, and harm fairness.
Transparency and Risk
"NASDAQ also wishes to ensure that its fee schedule does not provide excessive encouragement to members to aggregate the activity of several firms (some of whom may not themselves be members of the exchange) for the sole purpose of earning a higher rebate."
While Nasdaq has clearly expressed the commercial intent behind this proposal -- to prevent smaller firms that provide liquidity from earning the same rebate that larger firms may earn -- the likely consequence of this rule is that more activity will be consolidated behind a single MPID. As the proposal notes, member firms may employ multiple MPIDs to identify clearly the activities of various business lines, including internal distinctions among trade desks and distinctions among sponsored access clients. To avoid the economic harm resulting from this proposal, member firms will likely attempt to consolidate all activity into a single MPID. Doing so will obscure previously distinct activities, and thereby reduce transparency, severely curb the effectiveness of internal surveillance programs, hamper market regulation's surveillance programs, and render many existing risk management systems ineffective.
"NASDAQ believes that it is reasonable and equitable to offer its highest rebate tier to firms that provide volume through a single MPID, because NASDAQ believes that such firms are most likely to provide consistent liquidity during periods of market stress and to manage their quotes/orders in a coordinated manner that promotes price discovery and market stability."
If Nasdaq has based its analysis that the proposal is reasonable and equitable upon this assertion, it should justify this new distinction through evidence and:
(1) Provide detailed data on the activities of each firm that is expected to qualify for the high-volume tier under a single MPID to support this claim that "such firms are most likely to provide consistent liquidity during periods of market stress and to manage their quotes/orders in a coordinated manner that promotes price discovery and market stability."
(2) Provide data that supports the implicit assertion that firms that no longer qualify for the high-volume tier under a single MPID are not "likely to provide consistent liquidity during periods of market stress and to manage their quotes/orders in a coordinated manner that promotes price discovery and market stability."
(3) Explain the causal relationship, or any relationship at all, between providing superior preferential economics to certain firms at all times and under all market conditions, and incentivizing behavior during times of market stress.
The data in (1) and (2) are essential for supporting Nasdaq's new distinction between firms that should and should not qualify for this tier, and the general explanation of (3) will be helpful in explaining the general rationale behind this new theory.
"NASDAQ further believes that it is less equitable to pay a high rebate to a member that aggregates the activity of multiple smaller firms, since the higher rebate is not being paid with respect to the active quote/order management of a particular market maker or active liquidity provider, but rather simply due to the members willingness to allow other members and sponsored participants to channel low volumes of quote/order activity through another member."
As stated above, Nasdaq's position is that smaller firms should not be entitled to the same rebate as larger firms. Putting aside the question of how this is actually an equitable situation, the current proposal goes one step farther and attempts to curtail the ability of smaller firms to form consortia that aggregate volume in order to obtain rebates equal to those of large firms. It remains unclear how such restrictions are equitable, non-discriminatory, or promote competition among brokers (particularly small brokers), and Nasdaq should provide a detailed explanation to address this concern.