Nasdaq ’s Mackintosh on U.S. Market Data

By: Phil Mackintosh, Chief Economist, Nasdaq Feb 2023

Many outside the United States think the U.S. approach to market data represents the benchmark for others to follow. Many inside the USA would disagree.

Phil Mackintosh, chief economist at Nasdaq, provides an update on how the U.S. use of Consolidated Tape protects investors and rewards market quality.  

What’s so good about the U.S. Consolidated Tape?

With a fragmented market of 16 exchanges and over 30 dark venues, the Consolidated Tapes (CTs) do a reasonable job of creating a single virtual Best Price (NBBO) that includes venue and share quantity.

That Best Price is used to protect quotes, which also protects investors from getting executions at prices worse than those available on exchanges. The NBBO is also used for post-trade reporting, to quantify the price improvement (and dis-improvement) that clients with different sized orders received.

But perhaps most important, the Consolidated Tape has an economic model that rewards market quality. Improving the very data, and benefits, that the Consolidated Tape is expected to create. All users are charged for Consolidated Tape data, in rough proportion to their level of activity and the profits they make from the market. That revenue is then shared back with venues contributing data – 50% to those providing quotes and 50% to those providing trade prices and quantities. 

What’s so bad about the U.S. Consolidated tape?

Despite this apparent simplicity and purpose, many users in the U.S. think the Consolidated Tape needs an overhaul. 

Some complain that, taking up to 0.5 milliseconds to share a quote with the whole market, it is too slow. That’s partly true – and mostly due to geography (it takes only 0.02 milliseconds to actually compute the NBBO). As a result, stale quotes can hold up actual price changes. 

Although to be fair, a human blink takes around 250 milliseconds, so the current Consolidated Tape latency is more than adequate for human- speed investors.

If we think about the needs of professional investors, who profit significantly from their trading against other investors prices, it’s also important to realize all data is delayed, even proprietary data. Light moves no faster than one foot (30cm) each nano-second, so even a co-located server will see trades and quotes update after they have occurred and travelled from the matching engine throughout the data center.

Others note that with the U.S. stuck using round lots of 100 shares, an increasingly automated market trades with odd lots at better prices that are not shown on the Consolidated Tape, making it a poor benchmark for actual execution performance.

Some have complained about Governance of the Consolidated Tape, suggesting the whole industry should have a vote on how the tape is run, even though a conflict of interest exists for the users of the data created, largely, from market makers quotes. 

There are also two separate CTs, with primary listing venues historically doing most of the trading it made sense for them to be responsible for the NBBO for their stocks. But as many point out, that also creates duplication of resources and bureaucracy. 

Where are U.S. regulators with the Consolidated Tape?

Back in 2020 the SEC proposed a raft of changes that were intended to address some of the problems above.

To address governance complaints, a single Consolidated Tape and plan administrator was approved, with additional voting power to set data pricing given to the brokers and mutual fund groups. Although U.S. courts have since struck down that proposal having decided it was outside the regulatory authority of the SEC.

Although many data users would say the Consolidated Tape costs too much, the industry still persuaded the SEC to include even more data onto the Consolidated Tape. The SEC required exchanges to aggregate odd lots into “worst priced” round lots and also required the Consolidated Tape adds five more levels of depth, as well as Auction data (which is mostly used by professionals), even though none of those levels were provided with new regulatory or trading protections. The Plans proceeded to create a price-sheet for this ‘voluntary’ new data based on the difference between top of book and depth pricing at commercial terms around the world. Ironically, the SEC has denied the new price schedule, delaying the addition of this data to the Consolidated Tape.

To eliminate around half of the geographic latency, Competing Consolidators were also approved. These would be able to compile an “official” NBBO wherever they were located. In doing this, regulators eliminated the single virtual Best Price (NBBO) that many in the world think is a strength of the U.S. Consolidated Tape. They also create a situation where the speed of consolidating data becomes a commercial opportunity. As a result, Brokers will need to choose between paying much more for the fastest Consolidator or less for a slower version of the NBBO – and regulators will need to decide what is fair to their customers.

To address the odd-lot problems, dynamic round lots were approved. Unlike in most other countries, this sets different round lots based on a stock’s price so that the NBBO would always be at least $10,000 – which is large enough to complete the majority of trades – and ensures the NBBO remained a valid benchmark for execution quality reports. For example, a $250 stock would now trade with a 40-share round lot. Although odd-lots will still exist, with many smaller lots qualifying becoming round lots, spreads would tighten and the NBBO would also improve as a benchmark.

The SEC’s 2022 rules

In late December 2022 the SEC released four new rules which are mostly targeted at how retail trading is segmented from other investors in the U.S. market. These rules only address data at the fringes – adding a “best odd lot” price to the Consolidated Tape and using that in customer execution quality reports. They also accelerating the dynamic round lots proposed back in 2020 which will tighten the spread and improve the NBBO as an execution benchmark.

However, one of the more interesting aspects of the past two years was comments that the NBBO wasn’t as good as it could possibly be, and thus it was failing in its mission to protect investors.

But protecting investors is not all a consolidated tape can do. Research shows that more competitive public quotes improve liquidity and tighten spreads. That in turn reduces investors’ costs, especially for mutual funds working large trades. And when mutual funds can trade more, and more cheaply, their returns increase. As a result, and perhaps most important of all, research shows the costs of capital for companies also falls, helping to attract companies to public markets, adding to capital formation and making markets more efficient.