Counting Pennies

Stock exchanges derive revenue from a variety of sources, one such source is transaction charges or the rebate system. This incentive based transaction model is an important consideration for professionals and HFT, but less so for the discount based investor/trader. In addition to generating revenue for exchanges, rebates are also a contributing factor in market structure and trading activity.

While rebate based transaction models are common throughout the industry, this commentary will focus on Canada’s major markets, the TSX and Venture.

What are trading fees and rebates?

Prior to 2000, on the Toronto Stock Exchange, every trade was affixed a charge based on its value. There were of course other fees, but this trading revenue was substantial especially for the near monopoly operation. The burden of this value based model fell on those trading large cap seniors. Increasing competition forced the pricing scheme to be adjusted to paying only for aggressive trades, while passive trades were changed to no charge. This model continued to use the value based approach.

For those unfamiliar with the terms: passive refers to having a bid or offer in the book, which is also referred to as providing liquidity. Aggressive is hitting bids or taking of offers and considered to be removing liquidity.

While this change adjusted costs to some extent, it continued to place a heavy burden on firms trading actively in senior listings (this was especially true compared to US exchanges at the time), while making lower priced issues extremely cheap by comparison.
Further innovations in technology and regulation increased competition from not only US exchanges but also from new rules allowing for alternative markets in Canada (Alpha, Chi-X, and Pure etc.). As a result, the TSX eventually moved to a new fee schedule with 2 price tiers, below and above $1. This new volume based fee schedule provided rebates for passive liquidity orders and levied charges for aggressive trades or liquidity takers. The TSX earned the spread between these two fees.

The purpose of this pricing model was to encourage more liquidity providing bids and offers incentivized by the rebates and therefore generate more trading on the Canadian exchanges. This greatly improved the prospects of capturing a greater share of interlisted volumes for senior Canadian issues.

The fee spreads were initially fairly wide, but with the growth of the ECN’s in the Canadian market, the spreads further tightened, and are quite tight as of today.

If you go to the TSX site, click on: I am a professional, notices, then fee schedule, you can see the current fee structure for trading on the TSX and the TSXV (the venture exchange). You can see the fees and credits for market makers, post open trading etc. For simplicity let’s focus on the fees for active and passive in both high and low priced issues in some typical trading sizes.

You will note that fees for the high priced issues are tiered for volume but using the top number the fee for taking liquidity or aggressive trading is .0035 per share. That is a debit or charge of.35 per 100, $3.50 for 1000 shares or $35 for 10 000 shares. (Trading against Dark volumes is much cheaper)

Below those figures you will see the passive or liquidity providing credit: .0031 per share or .31 per 100, $3.10 per 1000 or $31.00 for 10 000. Again this applies to stocks that are $1 and higher (high priced equities) on either the TSX or the TSXV. The TSX nets the difference between the credit and debit on every transaction. Currently this spread is .40 cents for 1000 shares, but it was closer to $1.20 and higher as the rebate model was being developed. Canadian ECN’s use a variety of pricing models, some very similar to the TSX.

You can also see the low priced equity fees for stocks categorized as .99 cents or less: passive .0001 and active .0002. This translates to .10 and .20 cents per 1000 respectively or $1 and $2 per 10 000 shares. This disparity between low and high priced equity charges was designed to encourage trading on the junior market; which can have a material impact on analyst coverage and financings crucial to the potential success of these ventures. This difference also generates a great deal of activity around the $1 level.

The appearance and growing domination of the HFT computer trading fully utilizes these incentive rebates to earn profits and through their activities they have dramatically altered trading activity and market structure. First they will influence trading into other liquidity pools where their orders are more favorably positioned in the book to generate rebates. They also provide a rudimentary market making function using several batches of 100 share orders at given price points to generate rebates on the bids and offers.

Frequent trading at the same price over the course of the day is extremely profitable if you can generate enough volume; and creating the appearance of activity or direction with multiple passive orders can generate desired moves into these rebate generating passive bids and offers. HFT typically dominates trading in high priced equities that have over 100 million shares. This combination provides adequate liquidity to operate and healthy rebate income at very low risk whether there are capital gains or not.

You may notice that HFT seems to increase materially as a stock moves closer to $1. The reason for this is the rebate structure and the fact that the closing price establishes the rebate pricing for the next day. Because the fee structure cut off is .99 cents for low fee and $1 for high, the goal is to close the stock at or over the $1 mark so that the fee schedule turns to the higher rebate structure or remains there the following day. Conversely, a stock opening over a dollar will maintain that fee schedule regardless of whether it is trading below $1 until it has actually closed there.

The benefits of aggressive trading at the low fee schedule to accumulate positions and then utilizing the high fee schedule for increasing profits on rebates is a common strategy.

Clearly, counting pennies via the rebate system, recently developed by the for profit exchange model, has proven to be a boon for some. The result has also been new, superfast and sophisticated trading strategies and material changes in market structure and behaviour.