Subject: market data and market access (release no. 4-729)
From: Danny Mulson

Feb. 28, 2019

Dear Mr. Fields, 

First off, congratulations on your recent promotion. All the kids at Aberdeen High are very proud of you. 

Alas, the purpose of this letter is not to catch up with an old friends, but rather to set the record straight on market data fees. In recent days the folks at the Nasdaq Stock Exchange and Fitness Center have submitted another 'academic' paper the conviently 'proves' their market data and connectivity pricing is just super. Having not yet fishished grade 11, I was surprised to discover PhDs could write something so easily renounceable. 

Let me take this point by point.  

1) in point 6 of his sales deck, Professor Ordover states that many purchasers of connectivity are not dealers, and thus don't need to buy the product. This statement is made to support the theory of inframarginal customers. The point fails for two key reasons.  

First, the paper doesn't actually define who these buyers are, and what purpose they have for the connectivity. It is almost certainly the case that such buyers are vendors, selling trading and risk products, to brokers. These products would be valueless ex the connectivity. 

Secondly, the notion of inframarginal pricing is dependant on the mix of product purchasers. For example, say I invent a product that marginally improves the performance of a car engine, to the point some consumers would pay $50 for the component. Curiously the component can also be used to attatch lasers to sharks. As such, Dr. Evil would willingly pay a large sums for a small number of units. Pricing the product near Dr. Evil's limit would turn off all other buyers. As such, inframarginal economics suggests I price nearer the $50 level. But, if there were enough people looking to put lasers on sharks, it would make economic sense to price significantly higher and forgo the car improving consumers. 

Nasdaq is able to price at a higher level, because the demand for connectivity among the 'must have' consumers is great enough to ensure this is the most profitable route. This was highlighted by the gentleman from T Rowe Price, and the data roundtable, when he clearly stated he would not trade with any firm that didn't use direct feeds and connectivity. 

2) the Professor then suggests that traders' ability to shift some flow away from markets, based on connectivity fees, ensured supra-competitive pricing (bullet 7). In actuality, by allowing exchanges to offer tiered pricing for trading, the exchange is able motivate firms to send more, not less flow to their venues. The exchanges earn monopolistic rents on data and connectivity, which provides the ability to offer trading at levels upstart trading venues cannot compete with. The NYSE for example loses money on most, or all, continuous trades where a DMM is on the passive side, from a trading fee perspective. This loss is offset, easily, by data and connectivity fees.  

3) The paper then wanders is to an amusing comparison to running a gym, that is totally invalidated by the mere fact all portions of a gyms pricing are subject to competition, while much of the exchange product menu is not. Joint proctuct pricing is simple if one of your products is both desirable and not subject to competition. Increase the price of the non competitive offering, and if needed reduce other fees to increase the demand for the product not subject to competition. This is exactly what Nasdaq does. 

In bullet 35 the paper states that any increase in price of one component, to earn supra-competitive rates, will result in an overall loss of revenue in aggregate. When one considers this point, alongside the SIFMA letter on NYSE data pricing, and the lack if any evidence NYSE lost revenue while increasing direct feed rates, it is clear the exchange world is not subject to Professor Ordover's economics. 

4) The paper highlights that 5 of the top 10 users are able to earn a monthly cheque from the exchange, net of all trading, data and connectivity. This highlights a real issue. Why are smaller dealers subsidizing the activity of the very biggest players. It is no wonder smaller dealers are disappearing faster than Billionaires in Jupiter Florida. 

I could go on at length, but I have algebra in a few minutes. I hope I have made clear just how painfully unreflective this paper is of real world exchange pricing and economics.  

As always, stay woke