What Maker-Taker Fees Mean for You

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What Maker-Taker Fees Mean for You

Exchanges and a few high-frequency traders are being investigated for using a rebate pricing mechanism, which authorities say may distort prices, reduce liquidity, and harm long-term investors.

Maker-taker fees give a transaction rebate to those who supply liquidity (the market maker), while charging clients who use that liquidity. The primary goal of maker-taker fees is to increase trading activity on an exchange by providing businesses with an incentive to place orders, which increases trade.

Key Takeaways

  • Maker-taker fees, also known as payment for order flow, give rebates to liquidity providers in exchange for their participation in markets.
  • Market makers are those who offer two-sided markets, while takers are those who trade the prices established by market makers.
  • Takers who place market orders must pay taker fees, while makers who place limit orders may be compensated for satisfying orders.
  • With the development of algorithmic and high-frequency trading in the 1990s and early 2000s, the maker-taker system gained prominence (HFT).
  • A federal judge in 2020 banned a Securities and Exchange Commission pilot program intended to evaluate the effect of maker-taker fees.

Makers and Takers

Makers are often high-frequency trading businesses that rely heavily on specific trading tactics aimed to harvest payments. Takers are often major investment companies seeking to purchase or sell large blocks of stocks, or hedge funds betting on short-term market fluctuation.

The maker-taker approach contradicts the typical “customer priority” concept, which grants customer accounts order precedence without requiring them to pay exchange transaction costs. Exchanges charge market-makers fees for transactions and collect money for order flow under the customer priority paradigm. Order flow payments are then sent to brokerage companies in order to lure orders to a certain exchange.

Difference Between Maker and Taker

Limit orders are created by market makers, who then wait for them to be filled and prioritize execution at the best bid or offer. They make a spread on each transaction and often rotate their positions fast.

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Market takers submit market orders, which are often completed instantly, and favor liquidity and quickness. In terms of volume and quantity of transactions, market takers are less active than market producers.

Maker Fees

When a limit order on an exchange is not immediately filled, it increases liquidity to an order book for that asset. Because an exchange is encouraged to recruit traders and varied orders to their platform, it may offer a maker charge that is lower than a taker fee to the market player who is extending the order book. The market maker may be paid a fee for placing an order but may also be reimbursed for providing liquidity.

If a trade order is not promptly matched against an open order, the maker charge is paid. Investors may purposefully place limit orders that vary from the current price of an asset to guarantee they get the transaction from the maker’s viewpoint. However, in return for a maker charge, the transaction is not settled quickly.

Taker Fees

When a market order is made, it is often executed immediately. This sort of order depletes a security’s current liquidity on an order book. Because this is undesirable for exchanges because the security’s liquidity has dropped, exchanges apply taker fees to discourage traders from canceling current pending orders. In most cases, the taker charge is more than the creator fee.

If a trade order is executed quickly and removes liquidity from the market, it receives the taker charge. Traders may desire rapid order resolution and are ready to pay greater costs. If this is the case, the trader will instantly execute a market order.

An Added Incentive

The maker-taker strategy dates back to 1997, when Island Electronic Communications Network founder Joshua Levine devised a pricing scheme to incentivize providers to trade in marketplaces with small spreads. Makers would get a $0.002 per share refund, takers would pay a $0.003 per share charge, and the difference would be kept by the exchange. By the mid-2000s, rebate capture tactics had become a standard part of market incentives, with rewards ranging from 20 to 30 cents per 100 shares traded.

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Maker-taker pricing schemes are used by exchanges such as NYSE Euronext’s Arca Options platform, Nasdaq Inc.’s NOM platform, and BATS Global Markets’ US options exchange. The customer priority system is used by both International Securities Exchange Holdings, Inc. and the Cboe Options Exchange, which is controlled by Cboe Holdings, Inc.

Possible Pricing Distortions

Detractors of the technique argue that the rebates and other concessions make publicly available bid/offer prices in the market misleading. Some critics argue that high-frequency traders take advantage of rebates by purchasing and selling shares at the same price in order to benefit from the spread between rebates, which obscures the actual price discovery of assets. Others argue that maker-taker payments generate fake liquidity by luring individuals who are just interested in the rebates and do not move shares significantly.

One research conducted by University of Notre Dame finance professors Shane Corwin and Robert Battalio, as well as Indiana University professor Robert Jennings, discovered stockbrokers who routinely directed customer orders to markets with the greatest payouts. Their study discovered that when stockbrokers routed transactions to maximize rebate gains, order execution quality decreased.

A Closer Regulatory Look

In January 2014, Jeffrey Sprecher, CEO of Intercontinental Exchange (ICE) Group, Inc., which controls the New York Stock Exchange, urged authorities to investigate rebate pricing practices further. The Royal Bank of Canada’s capital markets business said in a letter to the Securities and Exchange Commission (SEC) that maker-taker agreements promoted conflicts of interest and should be prohibited. Following the uproar, Senator Charles Schumer (D-NY) urged that the SEC investigate the matter.

Former SEC Commissioner Luis Aguilar revealed in an October 2015 speech that the SEC is considering a pilot scheme to reduce maker-taker rebates. This pilot initiative would eliminate maker-taker fees in a small set of equities for a trial period in order to illustrate how trading in those securities compares to comparable stocks that still use the maker-taker payment system. However, in 2020, the United States Court of Appeals found that this investigation exceeded the SEC’s power, and the pilot program was terminated.

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How Do I Avoid Maker-Taker Fees?

Limit orders at a trigger price are used to build up an order book, which reduces taker costs. Market makers may be compensated for generating a platform’s liquidity rather than being taxed for taking liquidity through market orders.

What Are Maker-Taker Fees?

Maker-taker fees are transaction charges incurred during the placement and fulfillment of orders. They are the fees or reimbursements that an exchange charges or provides in return for the usage or supply of liquidity on the platform’s order book.

What Is an Example of Maker-Taker Fees?

In the early days of maker-taker fees, a market taker was paid $0.003 per share and sellers who helped complete the order were reimbursed $0.002 per share. The buyer pays to have their order filled, while investors who are waiting for their limit orders to fill get paid.

The Bottom Line

While maker-taker fee systems have seen an increase in popularity since their inception in the late 1990s, their future remains uncertain as academics, financial institutions, and politicians have called for regulatory scrutiny of the pricing model, which could result in significant changes in the practice.

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