Free Site Registration

Gone in Sixty Seconds or How Much Is Your Rebate Tax Bill?

Traders Magazine Online News, September 28, 2018

Elaine Wah and Stan Feldman

One of the biggest debates in the stock market over the past decade has been over “maker-taker” rebates: the practice whereby stock exchanges pay brokers and high-frequency traders to trade on their exchange. The SEC’s recent proposal for a transaction fee pilot has brought this debate to the forefront and is viewed by many as a much-needed step towards a deeper understanding of the impact of exchange fees and rebates on execution quality for investors. We applaud the SEC for their initiative and we’re looking forward to the valuable data that this pilot could generate.

One common source of resistance to the SEC’s proposal has been the consistent stream of “where’s the harm?” questions. Some industry participants insist that rebates are a boon for investors, and that removing them would result in poorer execution quality. Most in the industry, including some of the largest investors in the world, know this is a false narrative.

To corroborate the widely held belief that rebates cause investors harm,[1]IEX has studied and quantified one specific way rebates distort competition for executions: a silent, repetitive, systemic wealth transfer where some high-speed traders?—?and the stock exchanges who sell them speed advantages?—?are benefiting at everyone else’s expense. We call this the “Rebate Tax,” and it imposes significant costs on long-term investors.

Investors Suffer on Maker-Taker Exchanges

Here’s how it works: publicly available data shows that maker-taker exchanges (those which pay rebates for adding liquidity) have the highest market share and the longest lines to trade.


But as public comment letters have expressed[2] and as we’ve previously validated with publicly available data,[3] trades on maker-taker exchanges tend to perform worse than other exchanges. This happens because these trades often occur at the worst possible time: right before the price falls for buyers (or rises for sellers). This phenomenon is known as adverse selection.

An exchange’s order book is comprised of limit orders that line up at their respective buy or sell prices, forming queues/lines at each price level. Orders at the front of a line will trade first, oftentimes without immediately moving the stock price in an adverse way. As an example, a small undersized marketable order that would not impact the supply/demand of a stock would trade with an order at the front of the line, and would be deemed a high-quality trade. However, orders at the end of the line wait longer to execute and are more likely to trade with larger marketable orders. Therefore, orders at the end of a long line are more likely to be adversely selected.

For more information on related topics, visit the following channels:

Comments (0)

Add Your Comments:

You must be registered to post a comment.

Not Registered? Click here to register.

Already registered? Log in here.

Please note you must now log in with your email address and password.