Nanex Research

Nanex ~ 29-Aug-2012 ~ Rebates Trump Time and Size Priority

An Example of Maker-Taker Distortion

On August 28, 2012 trading in the stock of China Southern Airlines (symbol ZNH) provided clear examples of how time and size priority takes a back seat to rebates when order routing to the NBBO (National Best Bid or Offer). Basically, it doesn't matter which exchange is the first to post the best bid or offer price, because another exchange can match that price, even with a smaller size, and an ISO (Intermarket Sweep Order) is free to route to either exchange. This is actually allowed by Reg NMS.

From Question 4.04: Routing Single ISO to Best Displayed Price in an SEC FAQ on ISO orders.

For example, if three trading centers are displaying protected bids that equal the national best bid for a stock, it would be appropriate for a best-price order router to route a sell ISO of any size to any one of them, to any two of them, or to all three. In each case, there would be no better-priced protected bids that necessitated the routing of additional sell orders.

If one exchange with the same price as the NBBO offers a rebate for taking liquidity (this is called an inverse model and is used by EDGE-A and BAT-Y), then we might expect the order to route there. One question is, who keeps that rebate?

Below is a 10 second interval chart showing the National Best Bid (triangles)  and trades (all other shapes) color coded by exchange. The NBBO bid/ask spread is the gray shading (the top of the shading is the best ask, and the bottom is the best bid). There are four areas labeled 1 through 4:

  1. NYSE was best bid (dark blue triangles) but ISO order routed trade to EDGE (gold diamonds) which had same price (but not first in time, and with a smaller bid size). EDGE offers a rebate for taking liquidity while NYSE charges a fee.
  2. NY-ARCA became best bid (red triangles squished together), but order was still routed to EDGE which again had same price, but was not first in time and had a smaller bid size. NY-ARCA charges a fee for taking liquidity.
  3. Same as 1.
  4. NYSE increases best bid price before other exchanges have time to match it and trade executes at NYSE (dark blue circle).


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