Sec Speeches Cryptocurrency Statement on Volume-Based Exchange Transaction Pricing for NMS Stocks

A long line of economic literature asserts that competition among firms benefits consumers.[1] Competitive markets promote economic efficiency and growth, and their benefits can include lower prices and better products for consumers, as well as a more level playing field for small businesses that seek to enter new markets or expand their market share.[2]

In the realm of securities laws, in addition to investor protection, the Exchange Act requires the Commission to consider the effect that a proposed rule would have on competition.[3] Today we are considering a proposal that is designed to address a variety of concerns related to volume-based exchange transaction pricing (“tiered pricing”), including the competitive inequities associated with this type of pricing.

First, we are concerned about the impact of tiered pricing on competition between exchange members, such as when broker-dealers are competing for customers.[4] With tiered pricing, rebates go up and fees go down as a broker-dealer’s transaction volume increases on a given exchange, so that the more volume a broker-dealer transacts on that exchange, the better prices they get. This puts high-volume broker-dealers in a better position to offer lower commissions or fees, which may help them attract more order flow from customers—which in turn allows them to continue consolidating order flow to reach even more favorable pricing tiers as part of a self-reinforcing cycle.

While this cycle amplifies the competitive advantage for high-volume broker-dealers, it can disadvantage lower-volume broker-dealers, which tend to be smaller firms, since they cannot compete with larger firms for the order flow needed to get the best pricing. In fact, this cycle may be further magnified to the extent that smaller firms become customers of their high-volume competitors in an effort to qualify for better exchange pricing by routing some or all of their orders through their competitor. As others have suggested, existing rebate tier structure may play a role in picking winners and losers in today’s equity markets, limiting the competitive opportunities for firms that are unable to achieve the trading volumes needed to qualify for higher rebate payouts.[5]

Second, the Commission is concerned about certain exchanges using tiered pricing to preserve or extend their market power at the expense of inter-exchange competition.[6] For example, some primary listing exchanges base closing auction pricing on the volume a member executes during regular trading hours, in a practice known as “auction-linked pricing.”[7] This practice may incentivize members to route more orders to the listing exchange during regular hours to qualify for tiered pricing in the closing auction. This dynamic may harm the ability of non-listing exchanges to compete for order flow during the regular trading session outside of the auction.

Third, in addition to our concerns regarding competition, tiered pricing may present a conflict of interest between exchange members and their customers when routing orders.[8] Specifically, when a member executes an agency order, it faces an economic incentive to route the order to one particular exchange over others to achieve volume tier requirements on that exchange. While routing to that exchange would result in an economic benefit for the member in the form of reduced fees or increased rebates, it may be costly to the customer if it comes at the expense of execution quality.

Today’s proposal provides one possible avenue to address these concerns—a partial ban on tiered pricing, which would prohibit equity exchanges from offering tiered pricing in connection with the execution of agency-related volume in certain stocks, while also requiring transparency for tiered pricing related to member proprietary volume, among other things.[9] However, there are other ways to address these concerns as well, such as by adopting a full ban that would prohibit exchanges from offering tiered pricing for all volume in certain stocks, including both proprietary and agency-related order flow, as discussed in the Economic Analysis of this proposal.[10] Given these considerations and the proliferation of tiered transaction pricing schedules across many exchanges, I look forward to hearing feedback from commenters regarding the issues presented by this complex system of transaction-based fees.

For example, even though there are no third-party customers involved in tiered pricing for principal orders, volume-based pricing tiers still provide exchange members that engage in a high amount of principal trading with a competitive advantage in attracting customer order flow. Given this consideration, would a prohibition on tiered pricing that is limited to the execution of agency-related volume adequately address the concerns we have identified about member competition? Or, would a full prohibition on tiered pricing for all volume in certain stocks be more appropriate? Are there any practical concerns we should consider related to distinguishing between principal and agency order flow? Are there other ways tiered pricing may be hindering competition that we should be thinking about? I look forward to reviewing comments on these issues and others on which the proposing release solicits feedback.

Finally, I would like to thank staff in the Divisions of Trading and Markets, Economic and Risk Analysis, and the Office of General Counsel. I am deeply appreciative of your hard work on this proposal, and I am pleased to support it.