August 20, 2014
i do not believe that exchanges should be permitted to offer premium connection services of any type. the exchanges have a license to provide access to their datafeed and this datafeed is made up of individual orders from all traders. faster or better connections allow users to transact business before other users.
the datafeed which contains retail and institutional order flow are less likely to pay for premium services because they are not necessarily speculators. traders who want faster connections do so because they see the order flow before others and are able to buy or sell the order flow before others. faster datafeeds and multiple order types harm transparency (to non-premium users) and the speed of processing ends up creating an illusion of the order book for the retail/institutional user.
while exchanges have found a lucrative source of revenue from co-location, such services give advantages to their premium customers. this turns the retail/institutional order flow into non-public information that those premium customers enjoy. some of those premium customers are seeking matching transactions for the order flow, while others use the order flow to indicate interest. these uses of the order flow become "insider information", information enjoyed by the premium customers. worse, because of exchange rebates, these same premium customers are paid through the order flow of the retail/institutional investors. the problem is that the retail/institutional customers do not benefit from such services but they have to pay the exchange's price to transact business. the exchanges should be concerned about the practices that compromise the environment where retail/institutional customers must transact business.
premium customers willingly pay high feeds in order to enjoy their advantages. this should tell regulators that the advantages are worth a great deal of $ and the non-premium customer does not enjoy them. fees like this increase speculative, short-term behavior in the market and this increases risk. while some premium customers might choose a business model of an LLC, perhaps, many non-premium customers invest their retirement $ in institutional funds. to disadvantage retail/institutional users means that the users retirement funds might be compromised. does the SEC want to shift the environment in favor of professional traders to the detriment of people who are trying to save for retirement?
i think the datafeed is made up of individual orders, owned by the people who have placed the order, and not the exchange or premium co-located contractors of the exchange. the non-premium customers are forced to pay rebates through the transaction fee that the exchanges charge and they are forced to transact business with whichever exchange where their broker routes their order.
these practices have sprung up without regulatory approval. the SEC has requested that exchanges file rule proposals describing services that the exchanges already offer, rule proposals that describe exchange practices.
i think the SEC needs to carefully evaluate whether these rule proposals harm retail/institutional order flow, whether risk is transferred from the premium customers of the exchange to the retail/institutional users.
i think the SEC needs to view the exchange practices and decide whether these practices are in harmony with the mission statement of the SEC, in harmony with the principles of dodd-frank, whether these practices harm retail/investor order flow, whether these practices make it more difficult for regulators to discover an audit trail for particular transactions.
as far as i can see, these should be the SEC concerns:
*marketmaker benefits, qualifications, disqualification
*order types and instructions, particularly ones not enjoyed by all users
*exchange rebates, qualifying transaction rules
*co-location advantaging premium users
*exchanges disseminating late and inaccurate information
*exchanges and brokers beginning new services and practices without regulatory approval
*regulatory acquiesence to exchange practices without the exchanges going through the rule proposal process
*regulatory acquiesence to broker practices in opposition to rules or stated practices
*regulatory inability to curb illegal practices
why was the SEC uninformed about the practices of the stock exchanges?
the SEC is forcing investors to use a marketplace that is seriously compromised. the SEC has to represent the public interest, not shield brokers or exchanges from the results of their practices. it is true that if some of these practices were found to be illegal, some of the wall street firms might go out of business. but the idea of regulation is not to keep anyone in business.
speculation and shortselling are capital outflows from the market. they are not investors. the brokers and exchanges adopted roles as middlemen. but now they seek to write all the rules in order to advantage themselves.