MAKE AND TAKE FEES IN THE U.S. EQUITY MARKET

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1 MAKE AND TAKE FEES IN THE U.S. EQUITY MARKET LAURA CARDELLA TEXAS TECH UNIVERSITY JIA HAO UNIVERSITY OF MICHIGAN IVALINA KALCHEVA UNIVERSITY OF CALIFORNIA, RIVERSIDE Market Fragmentation, Fragility and Fees SEPTEMBER 17, 2013

2 Make and Take Pricing Model Makers Market participants that offer liquidity, i.e., post a non-marketable order or a quote Pay a Make Fee per share (where a negative fee is a rebate) Takers Market participants who remove liquidity, i.e., submit a marketable order to initiate a trade Pay a Take Fee per share (where a negative fee is a rebate) Make Fee + Take Fee = Total (Net) Fee if positive provides revenue to the exchange

3 History and Overview Origination 1997 Jeff Citron and Josh Levine, Island ECN Island opened doors in 1996 to begin competing with Nasdaq Stock Market. Island's market share of reported Nasdaq trades increased from approximately 3% in 1997 to almost 13% in Widespread after 2007 Predominant model US, Europe Equities, Options

4 History and Overview Money Transfer Nasdaq Exchange in 2010 $1,600 million from take fees - $1,094 million from make fees Net Fee Revenue of $506 million (net income in 2010: $395 million)

5 Recent Empirical Literature A single-fee-change event Malinova and Park (2014) an introduction of a negative make fee for a sub-sample of stocks on the Toronto Stock Exchange the liquidity rebate leads to decreased spreads, increased depth, increased volume Skjeltorp, Sojli, and Tham (2013) an increase of the take rebate by 100%, from a cent to two cents per 100 shares on Boston Stock Exchange and document positive cross-sided liquidity externalities where liquidity demand begets liquidity supply Lutat (2010) a reduction in the fee for making liquidity from positive to free of charge on the SWX Europe Exchange no effect on spreads, but leads to an increase in the number of shares quoted at the top of the order book Battalio, Shkilko, and Van Ness (2011); Anand, McCormick, and Serban (2012); Harris (2013); Battalio, Corwin, and Jennings (2014); Yao and Ye (2014)

6 This paper We study the effect of liquidity-based trading fees on market outcomes (such as trading volume, market share, and spreads) from the perspective of the exchanges. rather than looking at a single event or looking at the fees from the perspective of market participants We focus on the benefit to the participants on both side of the market

7 This paper (Cont.) We investigate the effects of these fees using daily data on all fee change events across all registered exchanges in the U.S. during the period from January 1, 2008 to December 31, 2010 by means of cross-sectional exchange-level regression analysis

8 This Paper (Cont.) Trading activity We explore whether an exchange's trading volume and market share depend on the exchange's total fee (Colliard and Foucault, 2012; Brolley and Malinova, 2012) We also evaluate whether trading activity is equally sensitive to changes in make versus take fees (Rochet and Tirole, 2003, 2006; Foucault, Kadan, and Kandel, 2013)

9 This Paper (Cont.) Quoted and Net-of-fees spread We explore whether an exchange's dollar and percentage BBO as well as the dollar and percentage BBO net of fees depend on the exchange's total fee (Colliard and Foucault, 2012) We also evaluate whether these market outcomes are equally sensitive to changes in make versus take fees (Rochet and Tirole, 2003, 2006; Foucault, Kadan, and Kandel, 2013)

10 Further We further investigate the possibility that the effect of trading fees on market outcomes is more pronounced when tick size is a binding constraint on the bid-ask spread

11 Fee Data from SEC filings Fees for different tapes Tape A: NYSE-listed Securities Tape B: NYSE Arca, Amex, and regionals Tape C: Nasdaq-listed Fees for different tiers Basic Competitive- high liquidity and high volume

12 Fee Data from SEC filings Fee Variables Nominal Fee- the actual recorded fee Relative-to-Rival Fee- the attractiveness of an exchange s fees compared to rival exchanges

13 Data CRSP data to identify listing exchange TAQ data for measures of trading activity and spread Panel Dataset Measured Daily from Exchange Analysis 14 Exchanges Tapes A, B, and C 108 make-take fee changes during the sample period Identified from SEC filings

14 Fees per 100 shares: Jan 2008 Dec 2010 Raw Fees Mean Median St. Dev Basic Tier Make Take Total Competitive Tier Make Take Total

15 Money Transfer Upper Bound using basic tier pricing Take fees: $1.171 million per day Make fees: - $0.710 million per day $0.460 million in net revenue on average per day $116 million on average annually

16 Money Transfer Upper Bound using basic tier pricing Take fees: $1.171 million per day Make fees: - $0.710 million per day $0.460 million in net revenue on average per day $116 million on average annually Lower Bound Using Competitive tier pricing Take fees: $1.124 million per day Make fees: - $0.992 million per day $0.132 million in net revenue on average per day $33 million on average annually

17 Trading Activity and Spread Variables Volume Vol: number of shares traded in a tape on an exchange Market Share MS: number of shares traded in a tape on the exchange of interest divided by the sum of shares traded for the same tape traded across all exchanges.

18 Trading Activity and Spread Variables Traded Quoted Spread BBO: the median each day across all time-weighted individualsecurity spreads in a tape on an exchange. True Economic Spread Adj BBO: the spread that an investor pays on a round transaction on an immediate execution calculated as BBO plus twice the take fee per share.

19 Results Nominal Total Basic Nominal Total Detrended Volume (0.012) Detrended Volume (0.039) Detrended Tape Volume (0.000) (0.000) Number of Observa@ons 17,470 17,470 R Regressions include date fixed effects All variables are in changes p-values in parentheses

20 Results Nominal Make Basic Nominal Take Basic Nominal Make Nominal Take Detrended Volume (0.066) (0.001) Detrended Volume (0.198) (0.002) Detrended Tape Volume (0.000) (0.000) Number of Observa@ons 17,470 17,470 R Nominal Make- Nominal Take (0.023) (0.007)

21 Results $BBO $BBO Nominal Total Basic (0.811) Nominal Total Competitive (0.668) Ex Dollar Volume (0.002) (0.002) Rival Dollar Volume (0.000) (0.000) Number of Observations 17,470 17,470 R Regressions include date fixed effects All variables are in changes p-values in parentheses

22 Results $BBO $BBO Nominal Make Basic (0.814) Nominal Take Basic (0.854) Nominal Make Competitive (0.875) Nominal Take Competitive (0.992) Ex Dollar Volume (0.002) (0.002) Rival Dollar Volume (0.000) (0.000) Number of Observations 17,470 17,470 R Nominal Make- Nominal Take (0.987) (0.859)

23 Economic Magnitude At the average daily volume and average total fee across our sample, our results show that a reduction by 1 cent per 100 shares is associated with a 19.04% reduction in the total revenue per day in a tape on an exchange.

24 Economic Magnitude At the average daily volume and average make and take fees across our sample, if the take fee is reduced by 1 cent the exchange' revenue decreases 17.51% in a tape, while if the make fee is reduced by 1 cent the exchange's revenue decreases 18.91% in a tape.

25 Subsample Analysis Below-Median Exchange BBO using Below Median Security Aggregation Securities Detrended Volume Detrended Volume Nominal Total Basic (0.013) Nominal Total Competitive (0.001) Detrended Tape Volume (0.000) (0.000) Number of Observations R

26 Conclusion Changes in the total fee are inversely related to changes in volume and market share at the exchange level A decrease in the take fee increases the trading activity on a tape-exchange more than a decrease in the make fee Changes in the total fee and changes in the allocation of the fee are not significantly associated with BBOs or BBOs adjusted for fees, at least not at the exchange level.

The Impact of Make-Take Fees on Market Efficiency *

The Impact of Make-Take Fees on Market Efficiency * Jeffrey R. Black August 8, 2016 Abstract Recently, stock exchanges have altered their trading fees to subsidize liquidity by offering make rebates for