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How Many Exchanges Is Enough?

Posted on: January 04, 2021

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September saw the debuts of the 14th, 15th, and 16th U.S. stock exchange, adding oxygen to a never-ending debate: How many exchanges is enough?

Communists say the number is zero; monopoly-lovers say it is one.  Beyond that, the commentariat is split between “a lot fewer than 16” and “the more, the merrier.” The first group argues that the costs of fragmentation exceed the benefits; the latter that technology mitigates such costs and that competition lowers prices.

We at CODA run on-demand auctions, so we naturally hate fragmentation—it is anathema to the concept of an auction.  But we also think the exchanges are themselves fragmenting the markets by executing trades bilaterally and sequentially, rather than multilaterally and simultaneously.  So we also believe in competition to their model.

The problem with the 16 exchanges is that they are all operating the same flawed market structure.  The only product differentiation going on is in the order types, and most of that differentiation is itself a byproduct of regulatory arbitrage—that is, exploiting the SEC’s Order Protection Rule (OPR) to attract order flow that would otherwise consolidate elsewhere.

Just look at Europe, where no OPR exists.  Yes, there is competition, but aside from brief periods of earnest new entry each national market has tended to settle down into duopoly.  This is because further competitors cannot, without the crutch of an OPR, cover their costs—which is another way of saying that they don’t add value sufficient to offset the scarce resources they consume in running a business.

Some will object that is unfair that a tiny order sitting on some tiny platform with tiny market share should not get executed before an enormous order at a slightly inferior price elsewhere.  But that is only to ignore the fact that such tiny orders would have migrated elsewhere absent the OPR.

In short, we at CODA abhor fragmentation and love competition, and believe that the right way to eliminate the former and encourage the latter is simply to repeal the OPR.

Don Ross is the CEO of PDQ Enterprises, LLC, the parent company of CODA Markets, Inc., a FINRA regulated broker-dealer which operates an electronic alternative trading system under SEC Regulation ATS.

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