By now, everyone tapped into the Nasdaq market knows that the success of SuperMontage could be significantly impacted by the rumored merger between the two largest ECNs: Island and Instinet. However, even if it decides not to join forces with Instinet, Island may opt not to participate in SuperMontage, due to a new regulatory-fee structure Nasdaq has implemented.
Back in mid-April, Island announced its intention to participate in SuperMontage, much to the delight of Nasdaq. But the ECN backed off of that commitment roughly three weeks later when Nasdaq unveiled a new pilot program that would charge ECNs and market makers regulatory fees based, in part, on a participant's total number of quote updates. The program, scheduled for a June 1 launch, also calls for Nasdaq to significantly increase the redistribution of its market-data revenues to participants that print their trades on Nasdaq.
However, since Island generates "virtually one out of every four Nasdaq quotes," the ECN believes the regulatory fees are unfairly weighted against its business, says Island Chief Executive Officer Matt Andresen. "What's really going on here is Nasdaq attempting to harm their competitor by passing on these (regulatory) charges in an anti-competitive fashion," he says. "What they've chosen to do is to allocate the costs of regulation based on the amount of quotes that you generate ... (but) we just think it's a little odd that a company with 140 employees should bear one-quarter of the regulatory burden for the entire (Nasdaq) marketplace."
A source close to Nasdaq retorts that quote updates account for only 40 percent of the formula the market has concocted for regulatory charges. The remaining 60 percent of the fees, he notes, are divvied up based on the number of Nasdaq securities in which a participant posts a quote (20 percent) and a participant's total usage of Nasdaq's Automated Confirmation Transaction application (40 percent). "We recognize that ECNs are very important in the quoting space, so we said let's not base our entire fee formula on that," says the source.
Regardless of the formula for the fees, there is no disputing the fact that Nasdaq's pilot program was created, in large part, to counter Island's decision to print the majority of its trades on the Cincinnati Stock Exchange - a regional stock market which rebates 75 percent of its market-data revenues to its executing broker/dealers.
Island, which now reports more than 90 percent of its over-the-counter trades to the CSE, opted to move its prints away from Nasdaq because it felt Nasdaq was not offering sufficient market-data rebates.
But Nasdaq officials say that Island's decision to print most of its trades on the CSE provided the ECN with an unfair advantage, because - prior to the launch of the pilot program - NASD members that reported trades away from Nasdaq did not have to pay any regulatory fees. "Under our old structure, if you were printing your trades on Cincinnati, you were basically coming off scot-free on regulation. And that's just not fair to everybody else," says the source close to Nasdaq. "We have got to pay the regulatory people, and it can't be that one participant does not have to pay any of that bill .... It has to be shared." Noting that the program is expected to produce a three-fold increase in Nasdaq's market-data-revenue sharing, the source says that Nasdaq hopes to entice Island to move its trade reporting back to the home market.
But Andresen says the program, in its current format, could in fact have the opposite effect, forcing Island to "completely leave" Nasdaq. "Nasdaq is not only trying to incentivize us to print 100 percent of our trades elsewhere, but quote elsewhere as well," he says. "I'm not aware of a case where charging a customer infinitely more money actually results in them doing more business with you. That may been part of their motivation, but I'm just missing the part where this motivates us to stay, because if we print (our trades) and we quote (on Nasdaq), we're hit with these (fees) no matter what."