The US Securities and Exchange Commission should mandate an experiment in cutting stock exchange fees and rebates, a move that could illuminate flaws in a pricing model that critics say creates conflicts of interest, a sub-committee of the regulator has recommended. High exchange fees have been cited as one reason for a rise in off-exchange trading, with nearly 40 percent of US stock trading taking place on lightly regulated private trading venues, up sharply from 16 percent in 2008.
Many exchanges also pay rebates to brokers that send them bids and offers not intended for immediate execution, providing liquidity for others to trade against.
Critics say the model creates conflicts of interest because brokers have incentives to send customers' orders to exchanges that pay the biggest rebates, not necessarily those with the best price or execution. Brokers say the rebates offset high exchange fees.
A subgroup of the SEC's Equity Market Structure Advisory Committee recommended that the regulator test reducing fees and rebates in three separate groups of stocks with market capitalizations of more than $3 billion for one or two years, in a memorandum on the SEC's website dated April 19.
The full committee, made up of equity market executives and experts, will meet on Tuesday to discuss the proposal.
Exchange fees are currently capped at 30 cents per 100 shares. Rebates are generally under 30 cents per 100 shares, but can be higher.
Under the experiment, fees and rebates would be capped at 20 cents per 100 shares for the first group of stocks, 10 cents per 100 shares for the second group, and 2 cents per 100 shares for the third.
The regulator would then be able to look at factors such as changes in trading behaviour on exchanges and private trading platforms, the impact on bid-ask spreads, and the amount of displayed liquidity for each group of stocks.
Nasdaq Inc ran a four-month-long experiment last year, lowering fees for a group of stocks to 5 cents and rebates to 4 cents. It found that it lost market share in those stocks as many electronic trading firms sought higher rebates on other exchanges.
An SEC-mandated experiment would apply to all exchanges, including Intercontinental Exchange Inc's New York Stock Exchange and Bats Global Markets. The sub-committee did not recommend a start date for the experiment.