February, 2010

In Traders Magazine, there is a meaty article on NASDAQ. See here :

Some key takeaways from that article:

-Nasdaqs fight to hang onto its share of the pie this year forced it to take its pricing model into the red. Inverted pricing. Loss-leader strategy to stem the slide.

- The upshot is that domestic equities is now a lot less important to Nasdaqs bottom line. Today Nasdaq takes in more money from domestic options trading than it does from domestic stock trading. And it has been aggressively expanding in foreign markets.

- Access Services is more revenue than domestic equities as well! Access fees being colocation fees! I.E. The exchanges auctioning off the right to milliscalp longer term players to the highest bidder.  See this chart:

Before I get to my point, I just want to make sure everyone understands how silly the inverted pricing structures are at the various exchanges. When an exchange, like BATS,  Nasdaq, or NYSE  wants to boost its market share it does so by inverting they maker taker models so that, the high volume firms (the only ones they invert for) get paid even more to TAKE liquidity than to PROVIDE it. Arbitrage opportunities ensue, market shares jump because microsecond traders who go home flat get an added pad to their margins to play High Freak Spin The Wheel at the exchange doing the inverting. Incidentally, usually the market share gains go away after the inversions do.

Whats my point? I guess it is that Nasdaq has a strategy of diversification in place which is (we get it) in its shareholders best interests. While certainly at times Nasdaq has been slow to adjust, now it is more nimble. It changes its pricing strategy constantly, tweaking  its maker-taker pricing system to fine tune its market share goals. Which also change frequently. It also has an inverted scheme for the High Freaks, and the 20-30 model for firms like mine. Nasdaq has diversified into markets overseas, and this has made the firm, according to Greifield, a global multi-asset exchange company.

So what is my point again? Our capital market system in the United States is so drastically altered, and it is altered  in such a short period of time. Exchanges like NYSE and NASDAQ were once charged to be fair and orderly, and were regulated by the SEC to insure that this is the case. A fair and predictable playing field is good for raising new capital (issues). The secondary trading done on these exchanges was done because these exchanges were perceived as fair for all investors.

So whats my point still? Well, if I were regulating these exchanges, I would have to ask myself how important a stable secondary trading platform and structure is to management of a firm that 1) constantly changes its pricing, 2) is increasingly more interested in events and structures in countries outside the USA (until those margins become painfully cruddy too), and 3) has its bread buttered by High Freak colo fees to such an extent that Colo revenue is larger than transaction revenue in the USA? The folks who run and monitor the playing field are so immersed in these short term tactics, with not one consideration for anyone who thinks and trades slower than a millisecond. I guess it can work out OK for long term players by accident; certainly not by design.

I dont mean to pick on NASDAQ; it just happens to be the exchange highlighted in this news article. I do mean for us all to ask ourselves some piercing questions. Is a sustainable market structure and infratsructure one that treats its participants differently dependent upon their margin, and is it one that can disappear should the margins for operating the exchange outside this country be greater than the margins for operating the exchange in this country? If you were a company needing capital to grow, would you pay to list on such an exchange? Would its goals match yours?

It seems that there is no one left in this country who wants new companies to form and have access to capital anymore. New companies  dont have the access through the public issuance market any longer (you see why), and they dont have the access through large banks (we have all seen why, unfortunately). I guess a new firm can hope to get money to grow and create jobs from an Angel Fund  that is started by a Bank, Brokerage Firm, or High Frequency Firm CEO.

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Themis Trading is an independent, no-conflict, institutional agency brokerage firm specializing in equities. The purpose of our blog is for a discussion of market structure issues as well as general market commentary.

Please note that third-party posts do not reflect the views of the Company and have not been reviewed by the Company for completeness or accuracy.

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