The decades-old argument over market-data fee structures is hot again in Washington, as lobby groups have called for a review of data pricing. Internet lobby group NetCoalition and the Securities Industry and Financial Markets Association (SIFMA) convinced the SEC to make a rare concession and review the pricing changes to the ArcaBook depth-of-book market data product from NYSE Arca (New York).
NYSE Arca intends to charge for ArcaBook data, which historically has been distributed to exchange members at no cost. NYSE's attempt to make a profit off of the data seemingly is a natural extension of the exchange's Reg NMS-induced transformation into a for-profit enterprise, which leaves the company accountable to shareholders. Other exchanges, including Nasdaq and the American Stock Exchange, have made similar efforts to charge for their depth-of-book data. However, the organizations that use the data are not going to open their wallets without a fight.
Protecting the Little Guy
The recent commotion over market-data fees was initiated by NetCoalition, an association of Internet-based businesses and Internet service providers, including Google, Yahoo and Bloomberg. Not long after the SEC granted approval of NYSE Arca's new fees for ArcaBook data last year, NetCoalition filed a petition over the action, requesting a review by the SEC on the grounds that the fees put individual investors at a disadvantage.
NetCoalition's interest in the issue stems from its members' provision of depth-of-book data to individual investors, who access the data through advertiser-supported Web pages, such as the finance content of Google and Yahoo. By charging for the depth-of-book data, the group claims that exchanges are making it financially inaccessible to the individual investor, whose trade decisions will be impacted by the limited picture of the market that is provided by free top-of-book data.
One vocal supporter of NetCoalition has been Charles Schwab & Co., which, though not a member of the group, conducts 95 percent of its business with more than 5 million retail investors online. "There can be no clearer answer than that customers are being disserved by the market data that's in place today," says Jeffrey Brown, SVP of legislative and regulatory affairs at Schwab. "The most clear example of that is the fact that the average bid or offer on an exchange is about 300 shares. Our average customer order is over 1,000 shares. On average, that 1,000 shares will not be executed at the best bid or offer." Retail investors will not know the true best bid or offer and cannot execute trades against it "unless they're willing to pay extraordinary amounts for that necessary data," Brown concludes.
But not all broker-dealers are on board with NetCoalition. "I don't have a ton of sympathy for any of these players when they charge money for advertising on their Web sites and part of their attraction is the real-time market data provided by the exchanges," says Joe Gawronski, president and COO of Rosenblatt Securities. "It shouldn't be a free lunch. The exchanges have costs in assembling and in distributing this data."
Broker-dealers, of course, have their own agenda in the debate; their interests are being represented by SIFMA. In comment to the SEC, SIFMA commended the decision to grant the NetCoalition petition, in addition to raising additional concerns of the broker-dealer community and requesting a moratorium on all market-data rule filings.
A primary tenet of SIFMA's opposition is that exchanges hold a unique position within the regulatory environment that has generated a conflict of interest. Exchanges are in complete control of market data and do not face external competition for providing the information, argues SIFMA. With increasing best-execution requirements imposed on broker-dealers by Reg NMS, firms feel pressure to purchase depth-of-book data in order to remain competitive.
While Reg NMS only requires proof of best execution against top-of-book data, the speed with which proprietary data products such as ArcaBook are delivered make them a virtual necessity. "These proprietary depth-of-book products that the exchanges are selling are being sold and advertised as being 60-times faster than the top-of-book data," notes Schwab's Brown. "If you get information 60 times faster than other people then you're going to have an advantage."
For those that are left with only top-of-book data, "It's very likely that the top-of-book [price] won't be there when they decide to trade because that information has been seen by someone else 60 times faster," Brown adds.
By distributing data products with such a considerable difference in speed, the exchanges are "recreating the floor-based advantage of their members, but they're recreating it in cyberspace," Brown continues. This uneven playing field makes products such as ArcaBook a necessary business tool for anyone looking to get a fair shake on any execution venue, and the exchanges' monopoly over the data raises the potential for inflated pricing, contends SIFMA.
Both NetCoalition and SIFMA agree that as exchanges demutualize and go public, the NYSE -- and by extension other exchanges -- have a right to charge for market data and, in fact, to make a reasonable profit. But both groups stress that there must be a method for the exchanges to show that their margins are fair and that prices aren't driven up in an attempt to improve the exchanges' shareholder value.
"The aggregation and presentation of this market data is a value-added service -- the exchanges should be allowed to charge for it," says Rosenblatt's Gawronski. "They have a right as a business to charge for this data, and hopefully reinvestment of those profits results in innovation that benefits us all. That said, it still needs to be closely monitored by the SEC and the industry."
Cost-Based Pricing Model
SIFMA recommends in its comment letter that the SEC "should require the exchanges to submit information regarding the exchange's cost to collect, consolidate and distribute that market data." Using a cost-based pricing model verified by the regulator would theoretically keep exchanges from pushing prices skyward.
SIFMA even goes so far as to recommend a business model for market-data sales. "A new market-data framework could include requiring each exchange to place market data operations in a separate subsidiary, and requiring each exchange to sell raw market data on the same terms to third parties as it does to its own subsidiary," wrote SIFMA's general counsel, Ira Hammerman, in the letter.
Meanwhile, the exchanges have been very vocal in asserting the fairness of current market-data pricing. "First and foremost, this data is not required. The SEC couldn't have been more clear in Reg NMS that what is required is top-of-book data," argues Ron Jordan, SVP of market data at NYSE. "The SEC was very clear that the exchanges have a right to sell their depth-of-book data. ... While some firms may want to use book data because it will help them compete, there's no requirement that they use book data."
Further, the exchanges have taken issue with the assertion that competitive forces do not impact the prices of market data. The pricing of market-data products has an impact on the ability to attract order flow, contends Jordan. If the data from any single venue is too expensive, firms will simply conduct their transactions elsewhere.
"The way that we maximize value to our shareholders is to improve our market share and trade as much value in our securities as possible," Jordan says. "Using market data to attract that order flow is very important. If we charge too much, the market will penalize us."
"We compete on listing, we compete on trading, we compete on market data," asserts Oscar Onyema, chief administrative officer for the American Stock Exchange (New York). "And as we all take a for-profit stand and as we move to a Reg NMS environment, ... it's counterintuitive to say that you should take market data and make it a utility base."
AMEX does not currently distribute depth-of-book data but intends to do so for its members that are demanding it, reports Onyema. "They actually want it -- they're the ones clamoring for the depth-of-book information, and they're willing to pay for it." <<<