Margaret E. Tahyar is a partner and member of the New York Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by Annette L. Nazareth, Lanny A. Schwartz, Gerard Citera, and Robert L.D. Colby.
In an action that potentially affects the business models of the U.S. options exchanges and major option market participants, the Securities and Exchange Commission (the “SEC”) recently issued a proposal that would cap exchange “access fees” for listed options and also prohibit exchanges from imposing unfairly discriminatory terms that inhibit access to quotations in listed options. [1] These proposals would extend to listed options two provisions of Regulation NMS that currently apply only to listed stocks.
If the proposal is adopted, it may yield a number of options market structure benefits, including: limiting the extent to which exchange fees cause actual execution costs for listed options to differ from the exchanges’ published quotations; rationalizing the operation of inter-market “trade through” requirements; reducing the practical issues with banning “flash orders” in the options market, as proposed by the SEC; and preventing an exchange from imposing unreasonably discriminatory fees on nonmembers seeking indirect access to the exchange’s published quotations through a member. However, the proposal would diminish the effectiveness of a common market model (a “Maker/Taker Model”), in which some exchanges attract aggressively priced limit orders by paying rebates for posting quotations that are ultimately executed against, and finance those rebates through access fees. Ironically, this likely would encourage markets to compete for customer orders through exchange-sponsored payment for order flow programs, which many have criticized on public policy grounds.