Welcome to an Uncompressed World: Higher Fees Imminent
Nasdaq no longer permits trade compression
July 14, 2008
Nasdaq Stock Market's elimination of trade compression, effective July 11, could prompt a sudden spike in clearing and settlement costs for broker-dealers, who will likely have to alter their trading strategies. And while firms can turn to other venues for compression benefits, that option may be short-lived.
Compression allows brokers to aggregate buy or sell orders into a single trade to submit to their clearing firms or the National Securities Clearing Corp. (NSCC), the equities clearing subsidiary of the Depository Trust & Clearing Corp. (DSCC). In April 2006, NSCC filed a proposal with the Securities and Exchange Commission to eliminate the practice, but the commission has yet to make a ruling.
Nasdaq decided not to wait for the SEC to take action, announcing in March that it planned to cease compressing trades for submission to the NSCC (Securities Industry News, March 10). Nasdaq was the only exchange--and the largest venue--to permit compression, the benefits of which have been a boon for high-volume trading firms who may only be making pennies on each trade. Nasdaq declined to comment.
Direct Edge CEO William O'Brien, former SVP of new listings at Nasdaq, said his electronic communications network (ECN) has been compressing roughly half of the trades it sends to clearer Merrill Broadcort, including those routed to Nasdaq. Direct Edge will stop compressing Nasdaq-routed trades, said O'Brien, "but we'll continue to compress with our customers who want to take advantage of those cost savings" for trades matched on the ECN. Direct Edge has been working with Merrill Broadcort to accommodate the changes.
Some broker-dealers may already have weaned away from compressing Nasdaq trades. However, the consensus last week was that tech-savvy firms would likely wait until the last minute to end the practice, resulting in a quick boost in trade submissions this week. "I believe there will be a significant volume bump in sides submitted to the NSCC," said Shane Swanson, former director of compliance at Mt. Pleasant, S.C.-based Automated Trading Desk (ATD) who is now a managing director focused on market structure issues at ATD parent Citigroup.
That could be a sign of things to come, if the SEC approves the compression ban proposal. The commission, however, has been working with representatives of the broker community and NSCC to reach an accommodation.
O'Brien said self-clearing firms may be less affected by a ban, since they submit trades directly to the NSCC, which has revamped its fee schedule twice this year to lower settlement costs for high volumes of smaller trades. "For firms that don't self-clear, and have less ability to restructure their clearing contracts accordingly, there could be a huge impact in terms of costs," since they may be bundling thousands of trades into a single submission, O'Brien said.
A trading firm could conceivably compress 50,000 buy orders into two submissions for which it pays clearing fees. "For a lot of firms," said O'Brien, "Nasdaq has become a much more expensive place to trade, and that may give a competitive advantage to Direct Edge and other firms that continue to compress."
Potential beneficiaries include the BATS Trading ECN--which declined to comment in light of its pending application for exchange status--alternative trading systems and large market makers such as Citadel Investment Group and ATD. But because exchanges do not pay NSCC settlement fees, the industrywide elimination of compression would put the alternative trading platforms at a disadvantage.
