Feb 13, 2019

February 13, 2019

How Stock Exchanges Abuse Their Privilege and Power for Monopolistic Profits

Illustration of a hand walking a dollar sign as though the dollar sign were a dog on a leash.

This article was originally posted on LinkedIn on January 29, 2019.

Today, I sent the following letter to Mr. Brent J. Fields, Secretary of the U.S. Securities and Exchange Commission, to publicly disclose IEX’s costs to provide market data and connectivity to our members. The disclosure provides critical evidence that supports long-held industry complaints that NYSE, Nasdaq, and Cboe have been abusing their regulatory position by charging excessive markups on products that many participants require to conduct their business.

Read the full report at The Cost of Exchange Services

Dear Mr. Fields:

Last October, the SEC convened a two-day roundtable to discuss the cost of market data and connectivity provided by U.S. stock exchanges, inviting participants from each of the exchanges, in addition to representatives from brokers, investors, and other industry stakeholders. While the roundtable dissected the topic in technical detail and was largely sidetracked by challenges of each participant’s business model, we believe the core focus of the scrutiny centers on stock exchanges and whether their unique position of power and privilege has been abused at the expense of all other industry participants.

IEX submits this filing from the perspective of a new and innovative national stock exchange with a goal of aligning the interests of investors, brokers, and the exchanges. Thus, our view on this topic offers a contrarian view to that of the entrenched exchanges, based on an operating model not reliant on selling speed and information advantages, paying rebates, or over-charging for required data and connectivity products. IEX is the last, and only, independent stock exchange which is growing, thriving, and founded on principles of fairness and transparency.

Exchanges Serve the Public Interest and Must Meet A Higher Standard

The most critical point in this discussion, which is often overlooked, is that stock exchanges are different. Stock exchanges are granted a license to operate by the SEC, which affords special privileges to exchanges, including granting them “self-regulatory” status with the power to discipline and penalize their members. Exchanges also have unique commercial power over their members and investors because participants are effectively required to connect to and obtain market data from all of the three entrenched exchange families. To regulate this power, the Securities Exchange Act of 1934 explicitly holds exchanges to a higher standard and requires them to distribute market data and conduct all their other operations on terms that are “fair and reasonable” and do not impose a “burden on competition” among their members. Exchanges are the only participant in the capital markets with this type of privilege and power.

For these reasons, the overall question the SEC roundtable sought to answer was: Are the fees that exchanges charge for market data and connectivity fair and reasonable — as required by the Securities Exchange Act of 1934 — and are they subject to market competition?

The entrenched exchange operators (ICE/NYSE, Nasdaq, and Cboe/Bats) all argue that the prices they charge for market data and connectivity are fair and reasonable and that they vigorously compete with each other in setting these fees. The rest of the industry, including investors, brokers, market-makers and IEX — as the only independent stock exchange — believes the opposite.

This debate has gone on for years in an echo chamber that lacks much objective data, because much of the data that would be helpful is known only by the exchanges. It is not possible to determine whether these fees are fair, reasonable and based on competition without a basic understanding of the economics of these products and services — first and foremost, what does it cost the exchanges to provide them?

It was clear to us from the roundtable that both industry participants and the Commission want and need better facts and more transparency. In fact, SEC Commissioner Robert Jackson specifically called out the need for more information from exchanges on their individual costs to provide market data and connectivity.

Evidence from an Exchange

After much discussion with our key stakeholders, IEX is taking the lead by creating and publishing the attached study (“The Cost of Exchange Services”), which details an in-depth review of our own costs for these products and services. We conducted separate reviews on three main elements of exchange fees: proprietary market data, direct connectivity, and logical connectivity (virtual sessions provided to each member to submit orders to the exchange). For each of these elements, we compared IEX’s costs to provide these services to fees charged by other exchange operators for comparable products and services.

Our conclusions include the following:

  • For depth of book data products, other exchanges charge fees 900–1,800% over IEX’s costs to offer a comparable product.
  • For physical connectivity in their data centers, other exchanges charge fees 2,000–4,200% over IEX’s costs to offer comparable services.
  • For virtual sessions needed to trade (“logical connectivity”), other exchanges charge fees 500–1,800% over IEX’s cost to offer comparable services.

As described in our report, the costs IEX incurs to offer these products and services include the same basic costs incurred by other exchanges. The potential profit margins that are implied by our study, on their face, contradict the claims by the major exchanges that the fees they charge the industry for their market data and connectivity are fair, reasonable, and competitive. In simple terms, the markups charged by the three entrenched exchange operators are only possible in markets where exchanges have de facto monopoly control over products that many participants require to conduct their business. This has a direct impact on those who must pay the overcharges, and indirectly limits competition by smaller firms (both sell-side and buy-side) that can ill-afford these significantly inflated fixed costs. Excess profits reaped by exchanges — and enabled by unchecked pricing power — also siphons funds away from the market that could fuel further innovation, promote choice and advance economic growth for investors and industry participants alike.

The Need and Demand for Transparency

We believe that IEX is the only exchange that is positioned, as a national stock exchange, to take the lead in providing data and transparency that is critical to this debate. We have built our market to deemphasize speed and to produce better results for investors and other market participants seeking to trade on a level playing field. Our primary goal as an exchange is to match buyers and sellers at fair and orderly prices, and the innovations that IEX has introduced to the market are focused solely on this goal. As a result, we charge a simple, low, flat fee to trade and reject burdening our Members with fixed costs for market data and connectivity.

Although we are distinct from other exchanges in many ways, the basic cost elements for every exchange, as we describe in our report, are very similar. All exchanges need to pay for hardware and equipment, data center usage, software, and related personnel (operations, product development, legal and regulatory, etc.). And as “The Cost of Exchange Services” shows, expanding capacity to accommodate more users should decrease marginal costs for physical architecture on a per-user basis — which dispels the notion that larger exchanges are more expensive to operate on a per-user basis.

The necessary components of infrastructure — space, hardware, and equipment — are commercially available from various sources that do operate in a competitive market. For example, the cost of a cross-connect cable in any third-party data center is negligible. The same is true of personnel — an exchange needs specialized and skilled staff, but their pay and benefits are determined by market competition. In contrast, the output of exchange products and services is uniquely unchecked by normal market forces and the excessive markups that are indicated in our paper are the unfortunate result.

The Way Forward

This debate cannot be resolved with rhetoric and misinformation. Although the New York Stock Exchange (ICE), Nasdaq, and Bats (Cboe) are publicly traded, for-profit entities, they also enjoy special privileges and status as self-regulatory organizations with a government issued exchange license. In turn, all exchanges, including IEX have a distinctive responsibility to help maintain a healthy capital markets ecosystem and must be held to a higher standard than any other participant. With this unique regulatory position comes the responsibility to prove that the prices they charge their members are fair, reasonable, and promote rather than undermine competition. The exchanges owe us all some answers

IEX hopes that this paper serves as a basis for further action by the SEC and will help both regulators and the industry challenge fees for market data and market access that fail to meet the minimum standards the investing public has a right to expect.


Brad Katsuyama