April 12, 2000
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Regulation of Market Information Fees and Revenues
Securities Exchange Act Release No. 34-42208, File No. S7-28-99
Dear Mr. Katz:
Fidelity Investments appreciates the opportunity to respond to the Commission's request for comments on the issues raised in the Concept Release on the Regulation of Market Information Fees and Revenues ("Market Data Release"). Fidelity Investments has extensive experience as a major user of market data by virtue of its investment management, through Fidelity Management & Research Company, of over 232 mutual funds in the Fidelity Group having total assets, as of February 29, 2000, of over $829 billion. Fidelity Investments is also a major user, as well as provider to its customers, of market data arising from its institutional brokerage operations, conducted through National Financial Services Corporation, and retail brokerage operations, conducted through Fidelity Brokerage Services, Inc. As of December 31, 1999, Fidelity Investments' brokerage units held $534 billion of customer assets in over 10 million retail accounts, including $269 billion held in over 3.4 million on-line accounts.
In the Market Data Release, the Commission has sought comments on a cost-based fee structure for the dissemination of real-time quote and trade data for equity securities included in the national market system. In particular, the Commission has solicited views of public commentators on how a flexible cost-based fee structure can be structured and administered and what information markets should disclose regarding their fees, revenues and costs.
Before turning to these points, which reflect the premise that no alternative exists to a system of regulated rates, we offer our general views on how the Commission should proceed in addressing market data issues.
A Competitive Model for Market Data Dissemination
In overseeing the development of a national market system for equity securities, the Commission, in our view, should seek, to the greatest extent possible, to allow competitive forces to operate. This means that the Commission's focus, in the first instance, should be on identifying impediments to effective competition and then determining whether those impediments can be removed, consistent with other public policy objectives, including, most importantly, the protection of investors. There should be a strong presumption that removing competitive barriers (such as NYSE Rule 390 or monopolistic pricing of market data) is the most appropriate regulatory action that the Commission can take, and that such action not only is consistent with investor protection but is the primary way by which investors' interests are advanced. Further, there should be a presumption that once impediments to competition are identified and regulatory action taken to remove them, adequate time should be given to allow competitive forces to shape the development of a national market system, before the SEC resorts to substantive regulation - including rate-setting or approval of rates set by self-regulatory organizations or their affiliates.
The Market Data Release proceeds from an unstated premise that competitive forces somehow cannot be brought to bear in the collection and consolidation of quote and trade data, and that effective competition is possible only in limited respects after that data has been consolidated by a central processor. That premise, in our view, should be tested. We suggest that the Commission should determine whether a competitive model could be developed for collecting quotation and last sale trading data from different market centers, consolidating that data and distributing it to end-users and vendors, as an alternative to the difficult, cumbersome and recurring task of rate-setting.
One competitive model that might be feasible would be to open up to competitive bidding the central processor function. In particular, the Commission should consider whether a competitive bidding process could be implemented that would award to a winning bidder a franchise, for a specified period, to perform all functions associated with a central processor or to multiple winning bidders who would carry out severable functions. Bidders could be required to compete on the maximum level of fees that would be charged, reflecting economies of scale and decreasing marginal costs associated with an expanding customer base. Among other things, bidders could be required to specify enterprise-level fees (again reflecting economies of scale) and fees for single users who access market data through multiple terminals. It is important that bids be submitted on the basis of maximum levels of fees, so that counterparties would be free to seek to negotiate fees at more favorable rates In this way, the Commission would enhance, for example, the opportunities for effective competition among vendors who could compete on the basis of passing through to their customers the benefits of lower rates negotiated with a central processor.
We recognize that a competitive bidding approach might renew debate over who "owns" market data. Although each market center may claim property rights for data stemming from trades or quotes originating in that market, it is dubious for any market (or group of markets) to claim ownership of consolidated market data or the right to be the consolidator of such data. In any event, as the Commission noted in the Market Data Release, the Securities Exchange Act of 1934, as amended in 1975, subordinates any ownership rights in market data to the Commission's exercise of authority to facilitate the establishment of a national market system - including authority under Section 11A to adopt rules to promote "the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities."
Transparency of Data Collection Costs
We believe that it is crucial that the Commission require that the central consolidator of market data submit regular reports to the Commission and make publicly available detailed, independently audited information relating to the cost of collecting, consolidating and disseminating market data. Such data should separately identify and quantify fixed costs and marginal costs. The Commission should also require that the categories of costs and their components be uniform for all networks, to allow for comparison of costs across the networks. Audited cost figures are indispensable if the Commission is to re-evaluate periodically (as it should) whether a competitive or a regulated model is preferable for this function. If a competitive bidding approach is implemented, this information is important so that prospective bidders can assess the barriers to entry that fixed costs may represent.
Transparency of costs, obviously, is essential if a rate-setting model is adopted, so that the Commission can determine the reasonableness and fairness of maximum fee levels. Among other things, a requirement that a central consolidator explicitly define and disclose its costs should reveal duplication of effort and overlapping costs among the four networks, as well declining marginal costs. Unsustainable profit levels will be subject to Commission and industry scrutiny and will be forced downward, as users and vendors negotiate fees lower than maximum levels.
A Rate-Setting Model
Although competition in the provision of market data should be strongly favored over regulatory rate-setting, we recognize that the Commission might conclude, after study, that competition is not presently feasible, and that the only alternative is governmental oversight in the setting of rates. If this conclusion is reached, we think that the Commission should revisit its findings from time to time as the nation's equities markets transform themselves in the immediate years ahead. We also believe that a regulated rate system must be based on three fundamental principles.
First, fees should be based upon only direct costs in collecting, consolidating and disseminating market data (together with a reasonable rate of return). Direct costs should relate solely to the costs of providing market data and should exclude costs incurred by a market center in operating its trading facilities or regulating the trading activities of its members. To foster competition among market centers, these latter costs for any given market center should be borne by those who choose to utilize the facilities of that market. Accordingly, a market center should recoup these costs from its members (through membership fees), issuers (through listing fees) and investors (through transaction fees). This approach would seem to be a necessary (though not alone sufficient) step to place the markets on relatively equal footing in competing for order flow and order execution, and would strengthen the incentives for each market to innovate, to deploy new technologies and to achieve greater efficiencies (all of which should lead to lower trading costs).
Second, fee levels should be structured so as to pass on the benefits of economies of scale and declining marginal costs of servicing an expanding customer base and to take into account the role played (and expenses borne) by vendors and others who, in turn, provide the facilities for transmitting data to their customers. In this regard, it would appear difficult to justify a fee structure under which a central processor imposes fees not only upon those who obtain market data from it directly, but also upon end-users who obtain that data from vendors and other secondary providers. Fees imposed by a central processor upon end-users more closely resemble royalties than cost-based fees, and it seems clear that Congress, in adding Section 11A to the Exchange Act, did not contemplate a royalty system.
Finally, fee levels should be set at maximum rather than absolute rates, so that vendors and others might be able to negotiate with a central processor for rates lower than the maximum. In this way, even in a regulated rate environment, some flexibility can be preserved to allow market forces to operate to bring down rates from their maximum levels. This approach should redound to the benefit of all end-users, as vendors can be expected to pass on the benefits of lower rates to their customers.
All of these principles are important to ensure that market centers do not reap cross-subsidies from the assessment of market data fees, and thereby impose restraints on competition for order flow and order execution. It bears noting that ECNs, which originate approximately 30% of the trading volume in NASDAQ-listed securities, already give away their quote information. Island, Redibook and Archipelago all have free public web sites showing the depth of their respective books. Some of these sites update their quotes dynamically, similar to Nasdaq Level II service. Archipelago distributes Island's quotes integrally with its own. All of these companies "give away" their quotes in order to attract customers, to show that they are the best place for customers to trade. As volume grows in ECNs and as more ECNs display their book publicly, information on market liquidity will increasingly be available free of charge. This, combined with declining marginal costs of information, suggests that in the absence of cross-subsidies, consolidated market data fees can and should be lowered from their present levels.
Indeed, for the data consolidator, the marginal costs for the additional retail end-user customer arguably approach zero. 1 A single connection from a network to Fidelity could support 100, 100,000 or 10,000,000 customers. If one looks to the pricing of Internet services, the price to end-users typically approaches zero in most cases where the marginal cost of production is zero. Only specialized value-added services have been able to sustain any pricing power; raw, undifferentiated data such as market quotes have rapidly decreased in price with the advent of Internet distribution.2
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The Commission is to be commended for undertaking to address the difficult issues surrounding the setting of fees for market data. The ultimate success of this undertaking, Fidelity believes, will turn on removing, to the greatest extent possible, impediments to competition. This means adopting a competitive model, if possible, for the central processing of consolidated market data. It requires that a regulated rate setting model, if adopted, should be based upon capped fee levels so that users and vendors will be able to negotiate lower rates from a central processor. It also means that regulated rates should be strictly limited to recovery of direct costs (and a reasonable rate of return), so that market data fees do not cross-subsidize other market functions (such as operation of trading facilities or regulation of trading practices) and thereby impose unfair impediments to competition among market centers. Finally, whether a competitive model or rate setting model prevails, the Commission should require detailed and public disclosure of costs associated with the collection, consolidation and dissemination of market data, so that fees are brought down over time - by either market forces or informed oversight by the Commission.
Fidelity appreciates the opportunity to comment on these very important issues, which are integral to the development of a national market system. We would be pleased to provide further information or respond to any questions that the Commission or its staff may have on the issues addressed in this comment letter.
Eric D. Roiter
cc: Annette Nazareth, Esq.
Robert L.D. Colby, Esq.
Belinda Blaine, Esq.
Daniel M. Gray, Esq.
1 See Shapiro and Varian, Information Rules, at 19-21 (1999).
2 Id., at 24.