Ok, it’s time for some game theory. For real! Let’s talk about the conflicts-of-interest at the heart of nearly all equity routing today – rebates & payments. These inducements (that’s an important word) influence how brokers route orders, for retail and institutions.
First of all, for retail, I think everyone understands that PFOF involves market makers paying brokers to send retail orders to them. Most of the time these are marketable orders. Limit orders are often sent to exchanges.
For example, here is Fidelity’s order routing showing marketable orders going mostly to Citadel and Virtu, and non-marketable orders going to NYSE and Nasdaq. Non-marketable limit orders receive a rebate when they are sent to an exchange
Those rebates are between 18 - 30 mils on Fidelity's routing to NYSE and Nasdaq (1 mil is $0.0001, so that's $0.18 - $0.30 per hundred shares).
Institutional orders OTOH mostly execute in broker-owned dark pools or on exchanges. These too are often induced to go to the lowest-cost venue – executing in a broker’s dark pool that is routing your order means the broker doesn’t have to pay any fees.
Executing limit orders on an exchange often means the broker collects the rebates (cost-plus routing is an option, but isn’t as common as it should be).
So that brings us to MEMX. MEMX is a relatively new stock exchange, partially owned/funded by Citadel, Virtu, a couple of retail brokers and other financial firms. Their market share has been climbing throughout the year (recently crossing 4%), although only on a per-share basis
By total dollar volume they are still under 1%. MEMX is a preferred destination for trading low-priced stocks in large quantities. Is this because of superior execution quality? Or is it because they pay the highest rebates of all exchanges, topping out at 31 - 37 mils?
But wait Dave – aren’t access fees capped at 30 mils by Reg NMS? How can they possibly pay such high rebates??

Yes they are, and I’m impressed with your market structure knowledge. That fee cap means that no exchange can charge more than a 30 mil fee.
So that means that MEMX is operating at a loss on those trades. How can they do this? Well they’ve got funding – they’ve raised $135M! So they can keep operating at a loss, and attracting order flow by paying the biggest kickbacks to brokers.
I’m talking about this for two reasons. First, it’s easy to focus on PFOF when we should really be concerned with all order routing inducements. Exchanges paying rebates is almost as bad as wholesalers and PFOF.
Second, it’s also easy to forget that we, the public, are subsidizing all of these exchanges, especially the ones that pay inducements. Paying these kickbacks results in more orders resting on the exchange, which nets them more of the SIP money that the public pays.
SIP fees are charged for every investor who sees a quote on their broker's platform (and other places), and amount to over $300M that are given to exchanges, which is economic subsidization that keeps exchanges profitable even when their execution quality is shitty.
Instead of an overly fragmented market subsidized by the public & inducing orders to be routing for kickbacks, we should aim to create a simplified market structure without subsidization or kickbacks, where orders are routed for the best possible execution quality.

End Rant.
I realize I forgot to tie this back to my first tweet's mention of game theory. This entire structure is a prisoner's dilemma that has led to a race to the bottom. When exchanges do the right thing by not paying rebates, they don't get market share. That's wrong & bad for mkts.

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More from @dlauer

26 Oct
Remember in February when Thomas Peterffy said:
"We have come dangerously close to the collapse of the entire system."

I just had a very stimulating discussion on the nature of systemic risk, market structure and leverage / shorting.

How is it even possible that GME could've brought something like this about?

Can you imagine if GME was responsible for the entire market grinding to a halt?
What's even crazier? Nothing has changed, 10 months later. We are 10 months after an event that could have brought the entire US market down, and nothing has changed. Nothing has been done. There is systemic risk in market structure that is not being addressed.
Read 11 tweets
12 Oct
This is the story all the current internalizer apologists want you to believe - "retail has never had it better." They neglect to mention the costs this has imposed on pension plans and mutual funds, or that the measurement is flawed because of artificially wider spreads.
Segmenting retail order flow harms markets, and widens spreads. Then those who champion this segmentation measure so-called "price improvement" against a wider spread, and claim "retail has never had it better." It's disingenuous, & of course those making the argument know that.
But Virtu, Citadel and the retail brokers are simply making too much money so they're desperate to maintain the system. They will fight the SEC tooth and nail on this, in order to preserve their annual bonuses.
Read 4 tweets
17 Sep
While this soundbite sounds good, it's not accurate. Using standard measures of market concentration, you can EASILY see that off-exchange trading is highly concentrated, and for large retail brokers it fits the DOJ definition for anti-trust enforcement.
The Herfindahl Index (HHI) is a standard measure of corporate concentration. Total OTC trading in July 2021 showed an index of nearly 2,000, but that doesn't tell the real story. Looking just at HOOD's 606, their HHI ranges from 2,500 (S&P 500) to over 3,000 for options.
This is the literal definition of corporate concentration, and it results in worse outcomes for everyone involved (except for the wholesalers and HOOD executives).
Read 5 tweets
15 Sep
You know what's terrible and sad? Earlier this year, Facebook's head of AI @ylecun told me, absurdly, that Facebook's "AI" "filter[s] things like ... bullying." All while he knew this to be untrue.
@ylecun Instead of responding rashly on Twitter, I wrote an extensively researched piece exploring Facebook's issues, including issues around harassment and bullying for the Journal of AI and Ethics:
link.springer.com/article/10.100…
@ylecun Facebook's problems are not technology problems, as the WSJ article so clearly establishes. It's problems are that it is a deeply unethical organization from top to bottom, and its business model enforces and supports that.
Read 7 tweets
3 Jun
This is absolutely the right take.

Something is rotten in these highly shorted names.

The more the general public learns about short selling abuses, short sale mismarking, FTDs and the complete lack of regulatory enforcement and oversight, the angrier they're getting.
There is an informed and fascinating discussion and level of research taking place in a decentralized way on social media. I don't think the SEC & FINRA have any understanding of the public disgust and upheaval, and if they think it'll eventually go away they're sorely mistaken.
This is building on the disgust of the bailouts and lack of criminal charges in the wake of the GFC. Now they're seeing companies being shorted and attacked, and retail investors are organizing and fighting back.
Read 5 tweets
2 Jun
When I tweeted about AMC squeezing a few days ago, a lot of AMC fans disagreed (some of you disagreed it was the subject of naked shorting too).

1 month ago AMC was trading at $10, and it's now over $60. IMO any trading professional would call that a textbook short squeeze.
It had extremely high short interest, and likely a significant amount of naked shorting. There was no fundamental data that came out that would result in a 6x increase in market cap / valuation. I have no idea if this is just the beginning or if it's the end.
Another important point - this squeeze has taken place over the course of a week. Closing prices: from May 24:
$13.68, $16.41, $19.56, $26.52, $26.12, $32.04... where will it end today?
Read 6 tweets

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