Several major public pension plans, including the California Public Employees’ Retirement System and the Ontario Teachers’ Pension Plan, have banded together in support of a new regulatory proposal that addresses a controversial practice they say benefits brokers at their expense.
The proposal, aimed at allowing pensions and other investors to assess the impact of stock exchanges paying rebates to brokers for order flow, grew out of years of controversy over the practice. Critics say these rebates undermine pensions and others’ ability to get the best price on securities transactions. The proposal caps fees and the size of rebates for market makers.
In a letter to the Securities and Exchange Commission co-written by OTPP and CalPERS and endorsed by other pensions — including the California State Teachers’ Retirement System, the State of Wisconsin Investment Board, all of New York City’s public pensions, and other institutions — the plans said they are in favor of the SEC’s transaction fee pilot program, which will test three different fee models over two years.
The SEC proposal also requires exchanges to publicly post the results and generate data to inform the industry’s debate on the subject.
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“In recent history, technical advancements and regulatory rulemaking have attempted to increase market competition and lower trading costs. Unfortunately, this has resulted in increased market complexity and various unintended consequences, and long term investors have borne the cost of this change in market structure,” wrote Kevin Duggan, head of execution and Treasury in the capital markets group at Ontario Teachers, and Don Pontes, investment director of financial markets at CalPERS.
The authors specifically pointed to the practice of exchanges paying rebates to broker members for order flow, “otherwise referred to as maker-taker or taker-maker pricing,” adding, “These pricing schemes as well as other fee incentives, have been generally criticized by a wide spectrum of asset managers, pension funds, endowments, members of Congress, academics and policy makers, including SEC economists, based on the potential conflict of interest it creates between brokers and their investor clients.”
The letter also highlighted some of the critical aspects of the proposal, including testing the elimination of rebates altogether.
“Without this test group, the Pilot will be of limited use to long-term investors who question the importance of rebates to overall market quality,” wrote Duggan and Pontes, who said they were writing on behalf of plans representing seven million members and $1.4 trillion in assets collectively. “Also, this will allow exchanges to compete on pricing and execution quality without imposing further price controls on the market.”
IEX Group — whose founders were at the center of Michael Lewis’s book Flash Boys, which chronicled how high-frequency traders used advanced technology and changes in regulations to skim off profits from long-term investors — supports the SEC’s proposal. IEX does not offer rebates.
“It’s extremely rare for so many asset owners and managers to speak as one on a markets issue — their support for the transaction fee pilot shows there’s a very real conflict that needs to be addressed,” said John Ramsay, chief market policy officer at IEX.