FINRA made news recently by publicly releasing the number of shares executed in what was once called the “upstairs” market – trades matched internally at brokerage firms without being routed to exchanges or dark pools. These figures include trades matched by wholesale brokers who purchase order flow from online retail brokers.
There was an extra two week lag in reporting volume for less popular Tier 2 stocks, but those results are now in, and the true division of execution market share has finally come into focus for the first time. The big picture is this (all data from FINRA’s ATS Transparency website or from BATS’ Historical Market Volume Data for the week of April 4, 2016):
| Venue | Shares Traded |
Market Share |
|---|---|---|
| Exchanges | 21,302,626,576 |
62.3% |
| Internalized | 7,802,071,312 |
22.8% |
| Dark Pools | 5,067,279,752 |
14.8% |
The general split of a little less than 2/3 on-exchange, split roughly equally among the three large exchange operators, and a little more than 1/3 off-exchange, weighted more towards interlizers than dark pools, should come as no surprise to industry followers.
What is news is how top-heavy the distribution of trading is within the internalized category. Two firms – Citadel and KCG – account for 25.6% and 18.5% (respectively) of all internalized shares traded, which translates to 5.8% and 4.2% of the entire market.
When the internalized and dark pool volume of firms that do both are combined, the league table of overall market share by parent company looks something like this:
| Venue | Shares Traded |
Market Share |
|---|---|---|
| NYSE | 8,453,981,723 |
24.7% |
| BATS | 7,009,032,837 |
20.5% |
| Nasdaq | 5,839,612,016 |
17.1% |
| Citadel | 1,994,798,333 |
5.8% |
| KCG | 1,621,841,065 |
4.7% |
| UBS | 1,225,650,483 |
3.6% |
| Susquehanna | 824,149,544 |
2.4% |
| Goldman | 656,737,754 |
1.9% |
| Morgan Stanley | 635,610,602 |
1.9% |
| DB | 630,489,765 |
1.8% |
| Credit Suisse | 625,641,609 |
1.8% |
| IEX | 558,987,508 |
1.6% |
| Barclays | 408,133,790 |
1.2% |
| Two Sigma | 401,592,433 |
1.2% |
| Citi | 400,021,795 |
1.2% |
| Merrill Lynch | 341,218,102 |
1.0% |
| JPMorgan | 339,746,329 |
1.0% |
Again, most of this table is not a surprise – the big exchange groups are on top, and the Tier 1 banks are in the mix below them. But the market power of the major electronic trading firms – Citadel, KCG, Susquehanna, Two Sigma – has never been clearer. Together those four firms account for over 14% of the whole market as executing venues, almost exactly the same market share as the Tier 1 banks combined, making the following a valid reorganized summary:
| Venue | Shares Traded |
Market Share |
|---|---|---|
| Exchanges | 21,302,626,576 |
62.3% |
| Big Banks | 5,263,250,229 |
15.4% |
| Electronic Trading Firms | 4,842,381,375 |
14.2% |
| IEX | 558,987,508 |
1.6% |
Moreover, Citadel has announced plans to acquire Citi’s ATD unit, which will shift about 1.2% of market share from the “Big Banks” category to “Electronic Trading Firms.” Commentary on the ATD deal suggests that Big Banks are not well suited to invest in the frequent infrastructure upgrades necessary to compete in the order matching space, and are therefore deliberately ceding it to the electronic trading firms who are.
Now for only question anyone talks about these days: What does this mean for IEX?
IEX’s exchange application supported by the Big Banks. Its exchange application is opposed by the Exchanges and Electronic Trading Firms. Is the battle over IEX’s exchange application really just a fight over execution market share?
There is some superficial appeal to this view. The firms that are still actively competing for execution market share have an incentive to keep new players out, while the firms that have largely given up on this business line are more willing to throw their support behind a new upstart.
But the opposition to IEX is based on these firms’ market making business lines, not their order matching. The most cogent opposing comments, from Citadel’s John Nagel and former Two Sigma (now Markit) exec Dave Weisberger, raise concerns that IEX’s “speed bump,” if permitted to be implemented by all exchanges, would force market makers to widen their spreads. The firms that stand ready to buy and sell at today’s tightest spreads are saying they will no longer be able to provide those tight spreads in a world where quotes are deliberately delayed and may not actually be accessible.
The downside of this scenario for investors is obvious. Wider spreads translate directly into higher overall transaction costs. One would expect Big Banks to oppose such an outcome, since they usually support whatever might help their institutional investor customers.
But the Big Banks have been IEX’s biggest supporters. Why don’t they want to keep their customers’ transaction costs down? They may be assuming more of their clients read Michael Lewis books than Citadel comment letters. They may be right.
Correction: An earlier version of this post incorrectly stated the ownership of IEX.
The post Is the battle over IEX’s exchange application really just a fight over execution market share? appeared first on Trillium Management, LLC.