In Conversation with a Market Structure Lifer – Brett Redfearn

PETER HAYNES: Welcome to TD Cowen's podcast series, Bid Out, a market structure perspective from North of 49. My name is Peter Haynes. And today, for episode 65, I'm very pleased to be joined by a market structure lifer, Brett Redfearn. While Brett needs no introduction to most of our listeners, for those of you who do not know his resume, I'll do my best to give it justice.
Brett spent most of his career at JP Morgan as one of Wall Street's leading market structure voices before turning to the other side of the aisle, or the debate, when he accepted SEC Chair Jay Clayton's invitation to run the Trading and Markets Division of the SEC in 2017. Brett stayed in that role through Chair Clayton's term as chair and now runs his own private practice, Panorama Financial Advisory, a firm that offers expertise in capital markets. Brett, welcome to the podcast. And tell us what's up these days at Panorama.
BRETT REDFEARN: Thank you, Peter. It's a pleasure to be here. I really appreciate the thoughtful content that you put together on this podcast. Panorama Financial Markets Advisory, I started that after my time, 14 years at JP Morgan, then 3 and 1/2 years at the SEC, then a brief stint at Coinbase. And I've been advising broker-dealers, asset managers, exchanges, fintech companies, really, on strategic and operational and regulatory issues and largely focusing on dealing with this crazy changing regulatory world that we're living in.
PETER HAYNES: Well, maybe your phone will ring a couple more times after listening to this conversation because I know we're going to cover a lot of ground. And you never know what we're going to uncover as we go through this discussion. So over the past few months, our market structure podcast series has been working its way around the world with pit stops in Europe and, more recently, APAC. Today is all about the US.
I want to start by asking you a couple of questions about your 3 and 1/2 years at the SEC. First of all, what was your biggest surprise you found out about the job running Trading and Markets? And did you ever second-guess your decision to leave JP Morgan for the Commission?
BRETT REDFEARN: So, look, the SEC experience was incredibly rewarding. I worked with amazing colleagues. It was great working under Jay Clayton's leadership. I really think he set a new high bar. I think it's actually missed both outside of the Commission and even inside of the Commission. I never second-guessed my decision to join the SEC and leave JP Morgan.
Perhaps there were times when I was a little concerned about the burden that it put on my wife and kids having to move and all of that. But no, it was just too interesting a job and a great experience. The division is huge. People don't realize the scope of the Division of Trading and Markets.
And so, while you and I and others focus on a certain set of areas, when you go in there, and you realize that you've got security-based swaps and opposite broker-dealer finance and at Reg BI. And there was just a very big scope.
So it was really intense, really broad scope and one of the hardest jobs I've ever had. But I would say the two biggest surprises probably were, one, crypto. I did not expect to be spending nearly as much time looking at Bitcoin issues, Bitcoin ETFs and initial coin offerings. That was a surprise. And the second thing was, needless to say, nobody expected COVID.
But when COVID came, and we had the market volatility in early 2020, and we were dealing with a world where market-wide circuit breakers triggered four times in 10 days. And that period of time was something else. And looking at how all of the markets worked together and some of the risks that were in there, it was scary. But it was also just a really intense and interesting time to be in the Commission and definitely a surprise.
PETER HAYNES: One of my friends that I talk to a lot about market structure gets frustrated when he feels like all the conversations are negative. And that he said, you need to do a podcast in all the good things that have happened in market structure. And you can point to things like Limit Up-Limit Down that came from the Flash Crash. Market-wide circuit breakers worked. People weren't sure whether or not the market would be able to behave properly.
So it's true. There are a lot of things that have worked well. And I'm glad to hear you didn't second-guess yourself in going to the SEC. I know there's been a running joke. And I want you to clarify this for folks, that the SEC's Division of Trading and Markets says 6,000 people focused on equities and one on fixed income. Has that actually changed?
BRETT REDFEARN: No. It's kind of funny. I remember, it was actually Dan Gallagher, who, at one of the conferences, came out and said that there was a half a person in Trading and Markets who was focused on fixed-income issues. So I think, as you probably know, when I got there, we stood up the fixed-income market structure advisory committee. So we put a lot more attention on to that. This was chaired by Michael Heaney, who was fantastic.
He now is chairman of Deutsche Bank Americas. Really, a lot more focus on that. I'm not going to say it was anywhere near the number of people who were looking at equities. It was still a relatively small number. But we did have a group of people focusing on that.
And we brought in a lot of outside expertise, which is something we did which we thought helped with to really listen to the industry cross-section of views to get recommendations. And they brought forth a lot of recommendations that I think were really constructive in terms of how we should be thinking about fixed-income markets.
PETER HAYNES: Well, that's good to know. And I know, obviously, the convergence of markets these days, as we look at the growth in active ETFs, largely driven off of fixed income. And those are all traded on exchange. The convergence of trading is something I'm sure we're going to be spending a lot of time about in the future. And you can add crypto into that and even sports betting. There's so much we could cover in this discussion, as I just mentioned.
But I do want to narrow in the focus on equity market structure because that's what we've been focused on both in our podcasts, on Europe and on APAC. And sometimes I feel like we kind of just bypass the US. I know it's a very big. But today, we're going to be totally focused on the US and some of the issues that have been dealt with but also remain outstanding from your time at the Commission.
So I want to start with a recent announcement that caught many market structure followers on Wall Street by surprise. And that was the announcement of a new Stock Exchange located in Texas. Interestingly, this exchange, to be known as the Texas Stock Exchange, appears to be more focused on the issuer side of capital markets than other recent Stock Exchange launches in the US.
What do you make of this announcement? And how would you think the industry should look at the success of the Texas Stock Exchange, say, three to five years from now?
BRETT REDFEARN: So look, competition is a good thing. We don't have a lot of competition in the listing space. We basically have the New York/NASDAQ duopoly which has been in place for a long time. And New York and NASDAQ, it's not cheap. There's uneven governance standards and rules between the way in which these listing businesses work. And there's just really not much competition.
No doubt, this is a formidable challenge. It is hard to challenge this. And issuers are pretty focused on that binary choice. But I think this is interesting. These guys are going to be worth watching. They're well capitalized.
So they raised, I think they said $120 million. Investors include BlackRock and Citadel plus a bunch of others. I think the state of Texas is motivated. They have a lot of big issuers in Texas. And now they have an increasing presence from firms like Goldman, JP Morgan and Charles Schwab.
Texas has really positioned itself in other areas as pro-business. And so I think that is going to be of some interest to issuers who don't love all the things that are happening in the Northeast. And we're going to have to watch and see. What are they going to offer for dual listings?
Is it going to be something that really does catch the attention of issuers? Will they eventually be looking at primary listings? Are they talking about the need to build out auction market functionality? Will they offer something new in auctions? So these are really big challenges. But I'm pro-competition. I'm happy to see competition coming into the space.
I think in terms of your question about, what would be a success, I don't think that this is a short-term play. It's going to take a long time because, to get listings, you're going to have to build market share. So if you're looking at a three-year period, I think you're looking at, are they able to get to that 2%, 3% market share number?
Do they have a dual-listings program that has people at least interested in that discussion about listings? And are people signing up for the dual-listings program? Are they changing the discussion around corporate listings and the standards for corporate listings? And ultimately, can they achieve profitability?
So in a few years, they figured out a way of bringing on dual listings, achieving profitability, and getting a reasonable market share. I think that will be a good three-year success metric. But I think, to really get into that primary listings business, it's a longer term play. And from what I know, I think they're in it for the long haul.
PETER HAYNES: And I'm of the impression, of all the exchanges that have come along and tapped into that listings mindset, has the most chance for success. I'm with you. I don't normally view these types of initiatives as having much of a chance of success.
But you look at Long-Term Stock Exchange, that would be a competitor in this space. They have two listings, I believe, and they're dual listings, one of which is a microcap stock. The SEC just received an updated filing from the Green Exchange, which, again, is attempting to-- actually, if you could call it the other end of the spectrum, focusing on climate specifically. But again, they'd be targeting what you call dual listings.
I'm with you, Brett. I think this exchange in Texas has a chance to take primary listings away from the incumbents. And you can just look at the gentleman who made the speech last night at the Republican National Conference, Elon Musk, as somebody who really could move the needle, as somebody who is of the mindset that would be willing to maybe take a chance. And assuming they can get the index providers and all the auction stuff in place, I think this thing's got a chance. And it will be very interesting to follow.
So we'll move on here to some of the rules that have been enacted and ended up in litigation, which, again, I'm sure is not something that you were anticipating would happen as often as it did while you were there. So it's no secret that some of the rules that have been enacted by the SEC do end up in this litigation. And you experienced that, unfortunately, with the transaction fee pilot that happened during your time there.
Another file that predated your time at the SEC but continues to be an open case in court is, who's going to pay for the now 14-year-old project known as the Consolidated Audit Trail or CAT? There have been no less than nine amicus briefs filed in support of Citadel and the American Securities Association suit against the SEC over the CAT. And who's going to pay the bill, which is now over $1 billion, that is, to develop the CAT and get it running.
First of all, I'm interested to know if a lot of your time was spent, while you were at the Commission, on the CAT file? And secondly, in the event the SEC loses, then, what happens next? I mean, there's $1 billion that has been funded by interest-free loans from the exchanges to this CAT LLC company. And somebody's going to have to pay that. So how do you think this is going to play out?
BRETT REDFEARN: So look, the consolidated audit trail is probably not mine or most people's favorite topic to discuss. It has been a very expensive painful process that we've been watching for a long time. And it has been messy, at best, in terms of trying to get it going.
It did take up a lot of my time. Peter, when I first got there, when we took a close look at what was happening with the CAT, as you can imagine-- so this is another NMS plan. So the NMS plan is governed by the SROs and controlled by the big exchanges. And the big exchanges, at that point in time, really weren't involved in industry.
Industry was complaining that there was all these meetings and plans being made and they weren't having their voices heard. So one of the first things we did was we tried to make sure that there was more industry involvement.
The second thing is, they were kind of wasting a lot of money with Thesys. So it wasn't well organized. It wasn't well managed. They had chosen a vendor that ultimately didn't work out. And I think that ended up in litigation as well. So that was quite problematic.
Jay Clayton really wanted to figure this out. I think that, while there are concerns that it may be a bit much and, at some point in time, maybe makes sense to scale it back a little bit, to help manage this, he actually hired what we call a CAT czar in the Chairman's office.
So we hired Manisha Kimmel. She came in. She was a CAT czar. She worked directly out of the Chairman's office because it wasn't just TM issues, Trading and Markets. It also involved other divisions around the organization. And she helped a lot. Quite frankly, she took a lot of that burden off of my plate, which was very welcomed. But while we were there, we passed a CAT fee incentive. We proposed amendments to bolster CAT data security. So there was a lot of things going on with the CAT.
I think, with respect to the litigation you're talking about, look, if you have an operating committee that is as conflicted as these NMS plans are, there are reasonable reasons to see why you're not going to get to the most fair or the most optimal outcome in terms of how these fees are being allocated. So I am not surprised to see that this is being litigated.
Quite frankly, I don't know what's going to happen in the litigation. But it wouldn't surprise me if this is further delayed and if the allocation methodology for these expenses needs to be revised in some way.
PETER HAYNES: And so that allocation, as has been approved by the SEC, basically the CAT LLC came up with it, and the CAT LLC is the exchanges, is one third of the fee goes to the buyer on a trade, one third goes to the seller on a trade, and one third goes to the SROs. And I think, as the industry has indicated, the SRO-- one of the SROs is FINRA, which is about a third of the volume, which is already said that they're going to pass that back to the brokers.
So now the brokers are up to 80%, and they're worried the exchanges will find a way to pass the other 20% back to them. So I'm sure that this issue is not dead. But at some point, they're going to have to figure out who's going to pay.
What about the interest-free loans that the exchanges were funding the CAT with? Do you know if it's indefinite that it's interest-free? Because we're not in an interest-free environment anymore. I'm curious if there's any transparency around that, or is that not something that's public?
BRETT REDFEARN: I don't know the answer to that question.
PETER HAYNES: Well, we're going to hear more, I'm sure, about the CAT. And one of the folks I was talking to indicated he thought it was a record number of amicus briefs on anything that's market-structure related because there was nine of them. And I've read some of them. They're dense. But it's an interesting topic.
Speaking of which I suspect when you joined the Commission, you didn't appreciate the need to be an expert in administrative law, nor did I in following market structure. That is certainly proving to be truer by the day. How do you think the US government agencies like the SEC will adapt now that the Chevron deference has been eliminated by the Supreme Court?
BRETT REDFEARN: So as you know, not only am I not an expert in administrative law, but I'm not an attorney. It was interesting to go into the Division of Trading and Markets. I think there were 175 lawyers working there. And not have a law degree-- quite frankly, as you know, I've read these rules and been in this stuff for quite a long time, but that always made it a little more challenging. I think Jay just wanted somebody there who was running trading and markets who actually spent their career working in trading and markets as opposed to a law firm.
But anyway, look, so Chevron deference-- this is very meaningful. I think people need to understand the fact that, for a long time, Chevron deference was in place. It meant that, when a statute is ambiguous or vague, judges defer to the regulators because they're the experts. And so for a long time, the federal judiciary has basically been deferring to agency's reasonable interpretations of ambiguous federal laws.
A lot of federal laws are ambiguous. They're reached by compromise. It's not clear-cut. So this has been an important zone in which regulators have operated to pass rules. And now the court has overturned that. And so the room to write comprehensive rules has been narrowed. The ability to challenge in court and win has increased. So quite frankly, I think, in some respects, the ability to govern on some of these things is somewhat limited and made more complicated.
But I would say this. I think, even before Chevron, the circuit courts had already been pushing back on agencies that have been overreaching. And agencies had been. I think especially recently, in the last administration, we've seen that happen quite a bit. And I think the courts haven't liked it. And so they've already been-- you see some of these cases where they've lost already. They've already been pushing back on some of that with respect to their statutory mandate.
So I think a lot of the practical effect was already happening. But what does it mean now? It means Congress has to pass clear legislation. It's not like we're not polarized at all in our politics right here. So I mean, getting that comprehensive, clear legislation is increasingly important. I think it'll be interesting to see what happens there. And then litigation. We've already seen almost an unprecedented amount of litigation even at the SEC.
And it's game on for challenging more rules. And that's going to be interesting to see what that means in terms of how our rule sets for our markets pan out over the coming years.
PETER HAYNES: Yep. The lawyers win. I think that's always the case here. And they're definitely going to be winning over the next few years. One of the points that you've made, when you compare the previous SEC administration, the one that you were in, to the current one, is that several of the market structure rule proposals that you brought forward were 5-0 votes by the commissioners.
Whereas, just about all of the rule proposals and final rules for the current administration tend to be along partisan lines and voted at 3-2. Do you think this is a sign of the times or a signal that the current chair is less concerned with consensus in his rule proposals?
BRETT REDFEARN: So look, first of all, it was really Jay Clayton's agenda and the Commission bringing these things forward. I did my small part. But for me, when we were going through this process, I worked very hard to get bipartisan support for rule approvals. Some of the rules we're going to talk about were 5-0. We got a lot of 5-0 votes. And it's harder. It means that, when you're working out rules, you have to sit down with both the democratic commissioners and the republican commissioners.
You have to take their comments. You have to make changes. You have to work things out between the two sides. And you need to get something that really represents a broader array of views. So I think we did that. I think we were a lot less partisan and politicized than what we're witnessing right now.
We were also trying to find the right answers for the marketplace. It wasn't about big political impact or making a big splash. It was really, like, what is good for the marketplace? And how do we incorporate the views of a wide variety of people into those decision-making?
I do not believe that this chair cares at all about consensus, and I think he said as much. I think that it's a much more political Commission. And I think, as a result, it's one of the reasons why the SEC is and will be spending an unprecedented amount of time in court.
PETER HAYNES: Yeah, that's for sure. And it's not going to end. And we're going to talk about some of those potential lawsuits as we go through some of the rule proposals here. So I do often wonder what happens to rules that are finalized under one administration but not completed and implemented until you get into the next administration. And that's even rules that have been finalized well before congressional review limitations.
And one of the rules that remains incomplete from your term-- and it was a topic that I know is dear to your heart, mine too, so much that you held a two day hearing at the SEC-- was the topic of market data. The end result, once rules were filed and not surprisingly litigated, was that you received approval for your proposed changes to market data infrastructure, but you lost in court-- being the SEC lost in court-- on governance of market data. Can you remind our audience of your efforts to address industry concerns over market data content and cost, and now what happens?
BRETT REDFEARN: So first, let me say this. When I got to the Commission, it was a party switch. There were other rules that had been proposed before we arrived. And that includes in trading and markets. The transaction fee pilot was proposed before we got there. So we had been passed the proposal phase. We were in the approval stage. Rule 605-- so the order routing disclosure, big order routing disclosure rule that included more things in there for institutional traders. That was also proposed.
We basically believe that, let's look at the rules that were proposed from the prior administration. Think about how to get this right. And we took them across the line. So we didn't just basically say, well, everything that was done in the prior administration, we don't like, for political reasons, or we don't like because it's not our idea. And unfortunately, I feel like we're seeing a lot of that now.
I think that, in terms of the work that we did and the ideas that Clayton was putting forth, it's sort of, like, ehh, that was their stuff. And I have no interest in that. That is kind of the sense that we've gotten. Now, with respect to market data infrastructure and governance, yes, these both were passed, 5-0. Both of these went to court. Market data infrastructure went to court and won. Governance also was litigated. And when we come up here, we didn't lose that.
There were three major provisions in the governance plan. And we won two of the three. So some people think that it was a loss. But we lost on one of the three. And quite frankly, I think the other two that we won on. And we won't bore people with the nitty-gritty details of all that, but were still meaningful. And so it's still a good plan, and it's still something that, if it moved forward, we would be living in a better world. So what were we trying to do?
We were trying to address several things. The first thing is that the pricing of market-- of proprietary market data had been on a tear, and competitive forces were not constraining prices. And so there were a lot of people in the industry who were complaining about the massive increases that were going on. And up until 2017, quite frankly, there was sort of a claim being made by exchanges that competition constrained pricing.
And so they were kind of being approved, almost rubber-stamped through. And that's one of the reasons why we saw that. So that was something we wanted to stop right away. Secondly, the content of consolidated data-- we have a great Tape plan in the US. And if you compare it to Europe, we're way ahead and maybe even to Canada up here. But the reality is, it hasn't been updated. It is lacking in content. It is substantially weaker than what you see in proprietary data feeds.
It is slow. It is consolidated in an inefficient way. It had not been updated for a long time. And so a lot of people were, like, we're going to have this. Why don't update this and get it right and try to figure out a way of making this have more value, not just to eyeballs, but to traders in the marketplace? So that was a goal.
The third thing is, if you want to fix this-- it's again, we're going back to the national market system plans. It is the governance body that determines, how do we fix it? Do we upgrade it? How do we price it? All of these decisions were being made by the self-regulatory organizations. And the Committee was controlled by the three large exchange groups which continue to have 12 of the votes on those committees.
So the dominant power over those committees-- and they are the ones who were selling the competing proprietary data products. So the conflicts were substantial and obvious. So we're, like, OK, we have to change the governance because we have to address these conflicts. And we have to fix that because, if we do, we're never going to be able to update the content. We're never going to be able to potentially have a better impact on pricing.
And the last thing was just introducing competition. If the Commission does not want to be in the position of being a rate-maker. And almost like you would regulate utilities and say, well, there's not competition, so what do we do with these prices? You need to try to figure out ways of introducing competition into the market. And so market data infrastructure rule had a provision in there to introduce competing consolidators.
So instead of having the monopoly that was controlled by the big exchanges being the only ones who sell consolidated Tape, we could have innovative companies coming in and figuring out how to do it faster, how to aggregate it better, how to provide services in order to bring competition into that space. And we thought that that would really improve that landscape. So that rule was approved. The reality is that they have sat on governance. It has not moved.
We're still waiting to see it happen. I don't think it's a priority, quite frankly. And market data infrastructure, with a couple exceptions that have been kind of plucked out and put into some of these other rulemakings, has also largely been ignored. So it's very frustrating to work that hard to get rules approved 5-0 and then to even win in court and to see nothing happen.
What happens next? I think it may very well-- we'll see if they ever get this governance plan out the door. I understand that there is some work happening on that. And if they can fix governance, then potentially you create a landscape where a new operating committee might be able to propose pricing that facilitates the introduction of competition. I think we'll just have to wait and see if that ever gets done.
PETER HAYNES: Yes. The first filing that the SRO has made over what I'm calling SIP 2, which was the heavy content SIP with market on closed data, depth of book and odd lots, was, frankly, a joke. It arguably was going to be more expensive to pay for the SIP 2 than to have received that information directly from the proprietary feeds. So I know they were sent back to do more work.
But it is frustrating to see these things just never happen, even though they're final rules. And I was told-- Brett, you probably know this better, obviously better than me-- that there's even some outstanding rules that were finalized in Dodd-Frank that haven't been implemented yet. So these things can go forever without getting done if the current administration doesn't consider them a priority. Is that true?
BRETT REDFEARN: We spent a lot of time trying to stand up the Dodd-Frank regime. I can tell you this because, as you know, that was passed a long time ago. And it was a priority while we were there of getting. And there was a whole slew of different Title VII rules that we passed, Peter. So we did make a lot of progress in that space.
But you're right. There's questions about, what are the priorities? And what is the bandwidth of the Commission? And that can really change over time. And let me just say one other thing that I worry about. Because I feel like there's a new precedent that was set here of ignoring or undoing the work that was done by the prior SEC. And the problem with that is markets like some degree of continuity.
We like to know what's going to happen next and where things are going. I mean, imagine if Reg NMS, when that was passed, another chairman came in right afterwards and they said, we're actually not going to do that. We're not going to do Reg NMS. We think that that's a bad idea-- after the whole [INAUDIBLE] and industry had debated it for a long period of time and that was going.
To a certain extent, there's a little bit of that happening here. And what worries me is, look, there's a good chance we're going to have a different president and a different chairman coming in in the spring. And when that happens, Peter, I worry, and I actually think it's probable that you're going to see a pendulum swing right back.
You just saw something happen. It's like, no way. Now it's our turn. And something like that could happen. And in some respects, I think that's a good thing because I don't like all of the policies that we're seeing here. And in another respect, it concerns me because the precedent has been set, and there will be an increasing lack of continuity in how we look at how these rules affect our market structure.
PETER HAYNES: And I know this gets pointed out a lot. It's not cheap to adjust your systems to conform to the new rules, T plus 1 being an example. It's not cheap for the industry to actually go through that process. Can you imagine-- I know this will never happen, but can you imagine if the next administration came in and said, no, we're going to go back to T+2, for whatever reason? Just to reverse these types of things would introduce a lot of cost.
I was speaking to-- I'll call it SEC expert recently-- he was asked the question, where do you learn about market structure? And the point that this person made was, the best place to learn about market structure is actually to read the SEC rule proposals. Because they tell you the history of everything. I think they're unbelievable.
And the other way, I think you can learn is literally by going to events that are hosted by, say, the SEC. And I think back to your roundtable on market data. And I cannot believe how much I learned just sitting in the audience throughout that day, things I had no idea about. And I thought the presentations were excellent.
And one of those speakers in October 2018 at your roundtable was Doug Cifu, who is the CEO of Virtu. And certainly he's the Stanley Cup champion right now. I'm sure he's very happy with his Florida Panthers. But he suggested that his firm, Virtu, could manage the SIP for less than 10% of the revenue that the SIP generates.
And in response and in defense of the current model or for fee practices, the exchanges that day introduced a new argument that I heard for the first time, and that was something called platform theory. Platform theory suggests that the cost to manage the exchange infrastructure cannot be separated into its components for data and trading specifically. And when you google platform theory, it's very hard to find much literature on this topic. What do you think of the exchanges who want to argue platform theory to justify current market data fees?
BRETT REDFEARN: Look, first, let's say this. Anybody who has a monopoly over a business will do anything to protect it, including hiring economists to write papers on platform theory. We'll start by saying that. So look, generally, what is platform? Platform theory says that exchanges compete at the platform level. So if data and connectivity fees go too high, then the market will lose market share in their transactions business because they've become too expensive.
And therefore, because of this, then competition is constraining our fees. And so we should be able to continue increasing fees and market data and connectivity. Competition will constrain all of that. And so, again, everybody knows we live in a Reg NMS world. There's fixed costs, and there's variable costs.
If you have to hit the best displayed quote, nobody's ever going to say, well, the New York Stock Exchange's data has become too expensive, so I'm not going to buy it anymore. Or now that I have to buy it, I'm not going to go to a market that might have a higher rebate or lower fee where I can have economics on different variable things. So without getting into the details of all that, it's safe to say that there has never been any true good evidence shown that platform theory actually constrains pricing of non-transaction fees, which include market data and connectivity.
The only thing that has constrained those fees has been the fact that the regulator-- and this really started, quite frankly, coincidentally, somewhere around 2017, Peter. And we came in, and we said, we no longer accept the assumption that these things are constrained by competitive forces. So you have to come up with some other reason why these fees are fair and reasonable.
That has actually-- as you probably know, we put out fee guidance as well, Peter, on how this should be done. And quite frankly, I think that review process has really done quite a bit to keep those fees in check. We are now seeing new platforms theory arguments being risen again. So NASDAQ recently put out a paper, and they included a lot of that paper in one of their proposals to raise fees.
And I'll just say this. I don't think that the Commission is finding those arguments particularly convincing. My view is, the only valid platform argument that makes any sense is that the larger exchanges who, for years had been able to really run up their fees and the margins on data and connectivity, compete at a platform level by using that revenue to cross-subsidize high-rebate tiers, high rebates, and other aspects of the marketplace that enables them to effectively outcompete and curtail any market share growth from smaller exchanges.
So there is competition at the platform level. The way that those fees have essentially been allowed to evolve has created what I believe is a anti-competitive dynamic at the platform level that hurts smaller exchanges who are trying to grow
PETER HAYNES: Well, I guess all you need to do is look at marketplaces that are offering rebates that are higher than the fees that they're receiving. And you have to ask yourself, why would an exchange ever lose money on a transaction? And then you have to think about how they're getting away with doing that? And where are they generating additional revenue from? So I'm sure that this topic is not one that's going to go away.
Another of the attack points for the current administration is exchange fees. And the SEC proposed a fairly complex revision to the current model of tiered pricing based on activity, which proponents will argue is common practice in most industries. What do you think about exchange tiering and the proposal that's out there from the SEC today?
BRETT REDFEARN: So look, this is a really hard one. And it's kind of a third-rail issue because, not only does it benefit the big exchange groups, but it also benefits big brokers, big quant funds, anybody who has a lot of order flow, generally. So nobody really wants to antagonize this group given their market power. The common file was relatively unsupported. There were a handful of supportive letters. But for the most part, it was quite negative.
My view, back to the last discussion, Peter, is that we talked about this cross subsidy. In that rule proposal there was a recognition that rebate tiers are cross-subsidized from other parts of the business. So I think it's interesting the way that that conversation links into this conversation. With some hesitation, my general view is exchange-based pricing tiers are anti-competitive to smaller markets.
They lock in volume at big markets, impose substantial financial penalties if firms move flow away. So even if you have a small, new, innovative market doing certain things, it's very hard to move liquidity to those markets. Because you're penalized if you miss your tier so substantially that firms just don't want to do that. So it makes that order flow very sticky.
So I would say, liquidity begets liquidity. And in this case, market power also begets market power. So I'm sorry that there wasn't more engaged debate on this issue in a real way. But my general view is that, because of the common file and because of the broad agenda of the Commission, I think this rule is going nowhere. I don't think we expect to see the light of day here.
PETER HAYNES: So you touched on something that I think is very important. And that is, when you're working for the Commission, who do you listen to? So let's think back to the transaction fee pilot and what we know was a letter-writing campaign that came from the exchanges. You know better than I do, hundreds of letters came from issuers, and they were copy/paste, copy/paste, copy/paste.
So if you actually were to say there were 2,000 letters that were opposed to the transaction fee pilot and only 10 that were in favor, the reality is, those 10 were informed, and most of the other letters were form letters. And you see this from various-- crypto is probably another example.
So when you're sitting at the SEC, and you see letters written about exchange tiers from certain participants who you know are conflicted, how do you discern that and think about, who are you going to actually listen to when making final rules or amending rules that are proposed?
BRETT REDFEARN: That's a hard question to answer. The Commission does take the letters very seriously. I always encourage market participants to chime in and get involved and try to put thoughtful letters before the Commission. They are read. They are synthesized. They are looked at in their entirety. And we try to make sure we have either a valid reason to say that it doesn't make sense or to try to let that influence the direction of policymaking.
And you will see, in many cases, as a result of letters that come in, the Commission will evolve the rulemaking between the proposal phase and the adoption phase. So I don't think it's a question of, who is it? I think it's a question of, are they cogent, good arguments? And if you don't have a good counterargument, and you can't articulate something that negates some of those points, you better pay good attention to it.
And this is where you get involved in a lot of data analysis. So in trading and markets, we had the Office of Analytics and Research. DERA has a ton of economists, very smart, PhD economists who can do analysis and try to come up with the data that helps to support one particular view or another. We have to do an economic analysis. As you know, a lot of the litigation ends up hinging on the economic analysis.
So I just think that you really have to do the heavy lifting and do real work and make good arguments one way or another. But we'd have proposals where one party or another would go out. And they'd get 300 types of firms to write like this form letter and drop it in the file. You'll see this in the common file. It'll be, like, letter type A-- we received 250 of letter type A, which all basically said the same thing. So it's not a matter of the number of letters. It's a matter of the substance of the letters and compelling nature of the arguments.
PETER HAYNES: So let's move on here to what I'll call the unknown. And that's the outstanding equity market structure rule proposals that are expected to go final sometime in the next few months. And I'll start with access fees and tick increments. So initially, the proposal from the SEC called for tick increments as low as 1/10 of a cent on so-called tick-constrained names. And immediately, most observers expected that final rule would not be to that level of increment.
And in fact, I think most observers thought that we would end up with a 1/2 cent increment on maybe the 1,000 most liquid names, and we still think that's where we go. So if the rule goes final at, say, a 1/2 cent on the most liquid names-- we'll call that a 1,000 securities-- do you think that DERA can provide enough economic analysis to keep this particular rule from litigation?
BRETT REDFEARN: So first, let me say this. And I've made this comment before about what I see as the Gensler administration's negotiation style of rule making where they propose rules that rational people know will never happen. So why would you propose something that's way over here? Because you know it's going to get dialed back. And maybe, as opposed to getting dialed back to five, you only get dialed back to seven, and therefore you get a stronger rule.
So yes, I agree that the rule as initially proposed-- and this is true with some of the other rules, like the order of competition rule-- would never have made it across the line the way it was proposed. And that might have been known up front. So that, in and of itself, is a little bit troubling. But I agree. I think that we're probably looking at a 1/2 cent tick for penny-constrained names.
Now, that looks pretty reasonable. And I think most people in the marketplace think, yeah, I think a 1/2 cent tick is a reasonable thing to try for penny-constrained names. The question is, what is a penny-constrained name? How do we define that? Is it going to be done well, or is it going to be an overreach? And unfortunately, out of this Commission, we're seeing a lot of overreach.
So my guess is that they are going to go over. Remember the proposal, Peter, penny-constrained names went out to $0.04. It was insane. Nobody thought a penny-constrained name went out to $0.04. And so I think that will also be dialed back.
But my gut tells me that it's going to be too big. It's going to be too wide. So I think a lot of the good research that I've seen done has it somewhere at-- if the volume-weighted average spread is 1.1 cents or less, then that makes sense. And perhaps there needs to be some depth at the inside market to show that there actually is some queuing of orders.
I think that the number is going to be wider than that. I don't know what it's going to be. But let's say it goes out to 1.5 cents. Then that's going to include, maybe 1,500 names or more. It's going to be too many names, and they're not going to be genuinely penny-constrained.
So then you ask the question, OK, if litigation is going to happen, could they actually litigate on the methodology that's used for penny-constrained names? I don't know. So I think, they want to go big. And the question will simply be, what do they think is the litigation risk based upon a methodological question like this?
I don't know the answer to that. But my concern is that it's going to be too wide. And look, if it's litigated and we have a new administration, it could easily be undone in 2025.
PETER HAYNES: If you talk to market participants, we all agree there's a certain subset of securities that the real market is somewhere inside a penny. So I think we all know that. This is back to the practitioners in the industry, of which you are one of them before you went to the Commission. So let's hope that there's a recognition here that there is some solution, some rule that needs to work, hope that it's not too wide, and hope whatever it is can withstand any potential for litigation.
So let's move on to access fees. This Commission attacked access fees by lowering them dramatically, at least in the proposal. The final rule, of course, we expect will look a lot different than the initial proposal. And I've heard two stories from different so-called informed market participants.
One is that access fees will be cut to 15 mils or in half on the names defined as tick-constrained with new tick increments as low as 1/2 cent, again, cut in half. And the other angle I've heard is that access fees will be cut to 15 or even 10 mils on all stocks. And I think you would argue that's probably too broad with the lower cap potentially leading to litigation by at least one exchange who I believe is threatening to litigate in that regard.
Your administration attacked access fees through a pilot. This administration is proposing a rule. And the administrative law experts that I speak with seem to think that, as this part of SEC rule making from within NMS amendments, would be protected from litigation. Given what you know now, how do you think the SEC will shape its final rule?
BRETT REDFEARN: So first, with respect to the transaction fee pilot, do you remember when people used to talk about data-driven rule making? The idea was that we could get data that would help to show what would happen if we tried access fees at different levels, or what would happen if we had a sort of a zero-rebate tier as well?
So think about this penny-constrained discussion that we're having. I would argue that, to a certain extent, the data that is being used for penny-constrained is actually being distorted somewhat by a 30 mil or more rebate. So if you eliminated that rebate, then there's a question of, would it still be penny-constrained?
So is it penny-constrained because it's just penny-constrained? Or is it penny-constrained because we have a rebate that's way too high there? And if you eliminated that rebate or you took the access fee cap down and those rebates went down, then what is the data that you have? So we knew that there was an issue with penny-constrained names.
But our idea was, let's try to get this right in terms of access fees. And then we can figure out what we need to do with ticks. In this particular case, the exchanges ensued, and they won that one. And they won that one for a variety of reasons. But in particular, that it looked like we were just doing a study for the sake of studying, and we didn't articulate a clear enough problem going in.
And that was one of the first things that hit me. That was definitely a lesson learned in the process of approving rules. But so anyway, so now here we are. What do we think is going to happen? Yes, I don't know. And it's probably Commission tries not to talk out of school and tell us where they're heading.
My guess would be that, for penny-constrained names, we will see the access fee caps drop to 15 or 10 mils. At 15 mils, I think the chances of litigation are a lot lower than they are at 10 mils. I think, if it goes to 10 mils, then there's going to be perhaps, what is the rationale that they're supporting in the EA that gets them to a level that goes to more than-- if you're only cutting the tick in half, that goes to more than half of that.
So I think that's where there's some potential litigation risk. But given this Commission, it wouldn't surprise me to see a 10 mil fee cap. And quite frankly, I happen to be in the camp where I don't necessarily think that's a bad thing.
PETER HAYNES: I'm with you. And I must say that I'm a little disappointed that, from a Canadian perspective, the plan, I think, is what they call do-no-harm plan is to follow the US lead but only cut access fees and only cut tick increments on any Canadian security inter-listed that shows up on the US list rather than coming up with their own proposal. There could be three names. And it seems ridiculous.
I just don't like that approach. But it appears that seems to be where our industry has coalesced, and, again, in part based on feedback letters that came from when the CSA asked for feedback on this.
I guess the other aspect, Brett, of the tick discussion that we haven't covered-- and people talk about this a lot is-- should we have higher-priced stocks have wider tick increments than a cent? And it reminded me of a discussion that you and I had had before we actually did this podcast when we were doing some prep work.
And you made an interesting point, and I wanted to expand on it. And that had to do with the impact of the move to decimalization in the early 2000s and its impact on degrading the value of the NBBO. Can you just explain what you mean by that?
BRETT REDFEARN: Sure. So I've been around, I guess, long enough because I remember decimalization. I remember going from 8 teenies, because we did that at the American Stock Exchange when I was there years ago. And then, we went to decimals, think about it, core data-- what goes out to the consolidated tape is the national best bid and offer.
So you get the best bids and offer from all of the markets. The wider the tick, the more liquidity that aggregates at that price [? point. ?] Therefore, the more of the depth of the market or the interest in the market you see in the national best bid and offer. One of the clear findings of the studies that were done after decimalization was that the size at the inside, the size at the NBBO got substantially smaller. And therefore, it was harder to see as much order interest in the market.
And that coincided with the evolution and the offering of depth-of-book proprietary products that were sold separately and that started to compete with the consolidated tape. So the depth-of-book products were being sold separately, and that came out. Now we're in a world where, if we go to 1/2 cent tick, we are basically going to potentially reduce the size of the NBBO, again, by half.
Because the interest at a penny might be then layered out over 2 pennies. People who buy proprietary depth-of-book products, they will see that liquidity. People who look at the SIP, they will not see that liquidity. So in addition to probably more flickering quotes and a bunch of names where there's less price stability at the level, there will be less there.
And so to me, what is very troubling is, when we go back to the fact that the market data infrastructure rule has been ignored, that said, already, based upon decimalizaiton, we need to add five levels of depth of book to core data so that people can see the order interest in the market. That should be part of the consolidated tape. You shouldn't have to buy proprietary data feeds to do that.
And that, not only was ignored, but now you're going to see a further degradation of the NBBO possibly in half without addressing these other issues. So I think that's a negative externality here. I have told DERA that I think that they should be looking at that as one of the factors. We had a lot of ink in the economic analysis of the market data infrastructure rule that talked about why we needed to have levels of depth.
So I hope that they have a fulsome discussion about putting the depth of the NBBO half and not, at the same time, adding any more depth to core data. Because I think that's going to be one of the costs and the negative externalities that results from all of this.
PETER HAYNES: I completely agree with you on that. So let me just ask you point blank, would you also support wider ticks for the Amazons, the thousand-dollar stocks, maybe a nickel or something like that? Would you support a move on the other end of the spectrum?
BRETT REDFEARN: So I think that the work that NASDAQ did there with their intelligent tick proposal is very thoughtful. And I actually think that that is something that I think deserves more attention, yes. What concerns me most of all, Peter, is that, remember, you have prop feeds and you have SIP feeds.
And so if you have a wider quote, what we found was that there was this inside market that was only visible to people who were buying prop feeds. So smaller firms and others who didn't buy the other feeds would not be able to see all this other order interest that was showing up inside of that. And so I think that piece of the issue would have to be thought through as well if we went in that direction.
PETER HAYNES: The last part of this discussion around the NMS proposals that I wanted to discuss is one I don't think is getting enough attention, and that's quoted versus traded prices. The initial proposal the SEC came out with matched quoted and traded prices for on-and-off exchange activity. Now, this could dramatically impact the ability of wholesalers and others to offer price improvement. Do you think the SEC will go final on this proposal?
BRETT REDFEARN: No. I honestly think that this was not a good idea. And I think that it died pretty early. So I actually think that this has been off the table for a while and that this is not something that we should expect. No. I do not expect to see this.
What morphed, Peter, was there became a discussion about, should they harmonize trading instruments? So instead of quoting increments and trading increments being the same thing-- so if you have a penny-wide quote, then you could only trade it a penny-- that idea to me made zero sense.
But the idea of harmonizing trading increments where, say, there was a 1/10 cent trading increment and wholesalers and exchanges both had to go with 1/10 cent trading increment, to me, that was worthy of more discussion. But my understanding is that that's not going anywhere either.
PETER HAYNES: Well, that's good to know. So the other aspect of the market structure proposals were both quite controversial. We've mentioned them already. And maybe they don't go final, but I to get your take. So the first is the best execution rule that is deemed to be too all-encompassing and duplicative with the existing FINRA rule.
And the second is to subject all retail orders to competition through auctions, the so-called order competition rule, with this one, literally, having zero industry support. What's your take on these two rules? Do either of them go final in some form?
BRETT REDFEARN: So we can just dispose of the order-of-competition rule first. Because I think it was an unworkable rule. I think it was really problematic. I don't think it could ever have gotten-- if it was passed, it would have died in litigation. So I think that one's largely dead, and we don't really need to talk about it. I'm not even sure how much attention that's getting inside the building at the Commission.
On best execution, however, I do believe that the Commission is trying to get this done. I would say that, for industry participants who are still thinking this through, this is an area where constructive engagement now would be warranted. Because I think they are trying to figure this out. I think that, because of Chevron and some of the other cases we've seen and some of the losses, I do believe this Commission is more sensitive to litigation than they have been in the past.
So keep in mind, if they keep losing in court-- this is just bad for the Commission. It's bad for the reputation and the strength of the organization. I don't think that they want to see that continue to get whittled away due to bad court outcomes based upon overreaching rules. So right now, with best execution, I think that they have some big problems that are going to be hard to resolve.
The rule, as initially proposed was definitely overly prescriptive and would need to be dialed back. It's hard for me to envision how you have two different best-execution standards for conflicted orders and for non-conflicted orders. I think that that's pretty messy.
I think that the EA is in trouble as well. Because if you think about the Economic Analysis, they have to be based on a baseline. So if the baseline of the economic analysis, which is around best execution, is coming after what I would expect would be the approval of 605, which we already know Rule 605 which is order execution, disclosure and broker dealers having to put out all their information. And that solves a number of the issues of best execution that they were concerned about.
And then a narrower tick with lower access fees which solves a number of the other issues that were being talked about. And now you have another rule that's still pretty prescriptive that is now solving for things that have already been solved. I think that's an issue in the economic analysis that would need to be addressed.
And also, by the way, if you go less prescriptive, it's actually, in some respects, it's harder for firms because then they don't know what to do and what's going to be the view of enforcement on any given day. And is it even going to be enforceable?
So I think that these are difficult issues. And I don't know what's going to happen here. I think this is a tough one. Maybe they pass a rule. If it goes too far, it will end up in litigation. And maybe they just don't even try this one, because it's too messy, and they've got too many other challenges on their hands.
PETER HAYNES: And they're running out of time. And I do agree with you that Best Ex is that one term. I probably hear that term when I talk to the buy side more from people that aren't on the trading side. They use that term all the time. And every time I look at people who say that word, I think, are you saying the same thing as the person that said it the day before or the day after?
It's different things to different people and a complicated topic. So I tend to agree. Maybe the clock runs out on that one. So it seems clear to me that Gensler decided he wanted to actually attack payment for order flow. But rather than going after PFOF directly, he went after it through the Best Ex rules, trade and quoted price alignment, and this order competition rule which we all agree is going to die.
I'm curious, if one of the goals of your administration, or Clayton's administration, in the access fee pilot or transaction fee pilot, was to attack payment for order flow but to do so through changing economics on exchanges for the better? Was that the ultimate goal that you were trying to get at with the transaction fee pilot?
BRETT REDFEARN: No, no, it wasn't. The reality was that 30 mils was this static number that had been put in place since it was proposed in 2004, 20 years ago now, Peter, 2004. It hadn't been revisited. There were a lot of questions about whether it was in the right place and to what extent were rebates actually creating part of this penny-constrained dynamic or creating churn with rebate strategies in the marketplace.
There was some question as to whether or not this was forcing some liquidity in dark pools because dark pools were charging lower take fees than this. And so certainly it was something that was on the radar. But as per a goal itself, I think the answer is, no. That's not what it was about.
Like I said earlier, if you really wanted to deal with some of these other issues, if you didn't try a zero-rebate bucket, then you wouldn't be able to have a basis to assess whether or not that penny-constrained nature that we're talking about was due to overly high rebates or something else. And so how do you fix that?
Now we're going in, and we're proposing a different thing where the access-fee math remains kind of uncertain. And to me, those things are integrally linked. It would have been nice to have had some data about how differential access fees and rebates affected that dynamic before messing around with tick sizes.
PETER HAYNES: Yeah, again, I have to agree with you. So here's the final question today. When exchanges switch to for-profit from mutuals, from a market structure perspective, I was actually supportive. I, like you-- I think you started your career at Amex. I started at the TSX. So I was at a time when it was a mutual.
So I thought, when exchanges became for-profit, I was supportive because it would bring discipline to those exchanges, innovation, efficiency, which is something I didn't see when I worked there, lower spreads for the industry, and lower cost overall in the exchange space.
So now I look back 20 years later. And I think the real winners of the demutualization process for exchanges was actually the shareholders. And if anything, I find today, we have more complexity, higher costs, and monopolistic behavior, which we spent a lot of time talking about today.
If you could put the genie back in the bottle prior to demutualization, then, when you have regulated the exchange business from the outset in a utility-oriented fashion around trading and data?
BRETT REDFEARN: So well first of all, you know how it is, Peter. Genies cannot easily be put back into bottles. And so the ship has sailed. And I don't think there's anything that can be done about that now. But when I look at this history of market structure evolution, I think that one of the periods in time when we got things a little bit off was-- we, being-- I'm speaking now sort on the regulatory environment got things a little bit off-- was when Reg NMS came around, it truly created competition in the transactions business.
Remember before that, Peter, it was like New York Stock Exchange, for years and years and years had 80% market share. And even just before Reg NMS, it was high 70% market share in its own listed names. And after Reg NMS, that number dropped down to 20s. So there was true introduction of competition. But when you think about the businesses, I've got a transactions business, I've got a data business, and a connectivity business.
I think what happened after that was, when that business got competitive and commoditized, then the question was, well, OK, well, we have these other businesses that really are not subject to competitive forces that still benefit from this SRO status and this status as being an exchange. And we're really going to be able to turn the dials on those businesses.
And so those are the businesses-- that's kind of when you start to see the escalation in those areas of pricing tick up and up and up. So I think that the regulator really missed the fact that there was these other key parts of the business that we're not subject to competition. And you still had this exchange license that had been granted. And the regulators hadn't done anything about it.
And then, for years after that, they rubber stamped a number of approvals, and they allowed that to happen. And that led to the dynamic we have now. And look, there are for-profit publicly traded companies that are maximizing shareholder value, and they've done a real good job at that. And if you look at the way that revenues and EBITDA has increased as a result of that, it has been good for shareholders.
But I'm not sure if it's been good for the markets as a whole or market participants. Because I think that, when these costs go up, you see increasing concentration in the top brokers and the top market-makers. You see less diversity. It's harder for smaller brokers to get into the game. It really has created a dynamic in the market that I think is lacking in some of the diversity and competitive forces that I would like to see.
And so that's why we focus so much on this issue, introducing competing consolidators, addressing areas where there are noncompetitive forces. It is one of the bigger challenges before the Commission. It seems to be one that has not been given much heed now, but I'm hopeful. I don't think it goes away. So they're still going to have to address this one way or another. It'll be interesting to see how it plays out.
PETER HAYNES: Well, any time I talk to a shareholder of an exchange, I'm always bringing up the warning signal around data, whether it's regulatory analysis in the US or here in Canada or anywhere else. So it definitely is something I think shareholders need to pay attention to. So today is my birthday. And people will ask me, what do you want to do on your birthday? And I would tell them, I get to interview Brett Redfearn and talk about market structure.
And I can't think of anything else I'd want to do. I know it sounds really nerdy. But I can't tell you how much I appreciate this conversation, how interesting it was, how much I learned, and I'm sure how much our listeners are going to learn. And for that, Brett, thank you very much for joining us today. And I know we learned a lot.
BRETT REDFEARN: Thank you. It's my pleasure to be here. And happy birthday, Peter.
PETER HAYNES: Thank you very much.

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