In the EU, Capital Markets Union (CMU) set to ban payment for order flow (PFOF), while Germany is trying to block it. This controversial matter stirs up debate in the US as well. One camp favors the SEC Chair Gensler’s hype about “order-by-order” competition published in a paper that clearly benefits auction markets, such as Apex CODA. Another group of academic researchers suggests ‘no evidence that PFOF harms price execution’. In an earlier article we pointed out various flaws with the proposal to route retail order flow to auction and offered an alternative approach. In this article we address questions we received and elaborate on how this Copyright Licensing Mechanism is relevant to solving not only the retail order flow but is a revamp with various incentives to market data/ market structure issues.
It is important to emphasize that our alternative approach is non-partisan. Our whitepaper since last year (page 05) stated that there will be a “willing buyer willing seller standard”, so rate setting will be market driven. The hypothetical 45%, 5%, and 50% royalty allocation percentages are merely the prevailing rates used by the music industry and we suggest that they are a reasonable base to facilitate preliminary discussions among market participants. We intend to ensure that rates would NOT be set solely and subjectively by any particular regulatory authorities or the self-regulatory organizations (SROs). Learning from the music industry, objectivity would be preserved in something similar to the “Four-Part Test”.
We have considered royalty earning opportunities for both ‘algorithm publishing’ and ‘recorded trade/ order sequence’. For that, we should have better clarity in describing the “DJ mixing engineer” role and how retail investors would benefit from a royalty pass through via the Copyrights Licensing Mechanism. Retail brokers or other non-algorithmic market participants aggregating order flow upstream would record trade/ order sequence into songs daily. These songs would entitle the corresponding brokerage firms with 5% royalties in compensating their effort as “DJ mixing engineers”; 95% would be a pass through.
Why would retail investors want their orders to be routed to auctions, swamped by specialists moving blocks, when this royalty pass through mechanism will potentially earn them another $10, $20, or even $100? Our intent would be to highlight algo developers or other featured artists (traders) who are interested in earning a 45% royalty. These generous rates, however, are also accompanied with potential liabilities if trade activity results in manipulation or market chaos. We want to align rights with corresponding obligations.
While consideration is given to firms turning their unused algo into a second profit opportunity, underpinning the concept of a “sound library”, those who lack resources for A.I. machine learning and/or other sophisticated techniques can benefit from obtaining license rights to use algorithms, from the library, to accelerate their own algo development lifecycle. A “community library” can gradually be built using trade patterns from past prosecuted cases as a start. Average investors may leverage any ‘music editors’ to mix-and-match different patterns to form a new algo and have it back-test in simulated environments. Creativity to discover unknown unknowns will be anybody’s game minimizing the gaps between the ‘haves’ and have-not.
This is a simpler market structure. It will help weed out conflict-of-interest, curb rent seeking behaviors, and address issues of arbitrage or a particular type of trading venue at competitive disadvantage compared to other streaming platforms. All streaming platforms, including SROs, Alternative Trading Systems (ATSs), Internalizers, and Communication Protocol Systems (CPSs) would have to bear royalty payments and earn appropriate subscription fees.
The SEC and policy makers around the World should welcome this approach, whereby the ‘sound library’ and ‘catalogs’ improve transparency and address concerns about Black Box Algo. The mechanism would better help identify rogues based on the source of earned royalties and intelligence of whose order flow may be interacting with whom to effectively curb desk hopping behavior that dodge regulatory oversights. Nevertheless, we believe the crowds’ intelligence in real-time is substantially superior to finding a needle in the haystack, i.e. the Consolidated Audit Trail (CAT), to address and prevent future flash crashes. The SEC and policy makers around the World should enable market driven innovations rather than directly dictating the design of markets. For that, a no action letter to nurture development within a sandbox would be a nice to have, whilst copyright laws may serve as relevant guidance regarding the project implementation.
In an attempt to play the devil’s advocate, what if someone said, “Copyrighting trade strategies would expose the secret to our trading success. The law covering data and copyright is confusing and unpredictable. The state of data licensing, lack of license terms, layered rights, are vague or copy-left licenses open-source software style licensing does not work for data. W3C ODRL standard licenses have not developed properly for data. Current practices in data licensing are a mess. It is not worth the risk.” In our opinion and per Chris Steiner, “Algorithms have come to rule our World”. Many are using algo wheels. Reverse engineering to unveil others’ trade secrets is inevitable. When risk cannot be fully mitigated, it is better to protect it via active monitoring. Choice is available if one does not want their trade strategies to be copyrighted, in turn they will not earn any royalty.
Think about what gives rise to arbitrage or pick off on price. Anyone would have done it if they don’t have to bear the corresponding cost in using others’ copyrighted materials. BestEx, order protection and ways to curb conflicts of interest all boiled down to tweaking incentives causing it to be economically not viable for a constituent to exploit its economy of scope, scale, or engage in other misbehavior acts. Don’t you want to assert claim to your own data?
At Data Boiler, we believe the determination of What Gets Paid and Who Gets What must base on clear delineation of rights and obligations. The industry has suffered, while Activist groups and lobbyists polarize issues and demonize their opponents. We are innovating, leading change, and creating viable paths toward sustainable growth of the overall pie.
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By Kelvin To, Founder and President of Data Boiler Technologies At Data Boiler, we see big to continuously boil down the essential improvements that fit for your purpose. Between my patented inventions and the wealth of experience of my partner, Peter Martyn, we are about finding rare but high-impact values in controversial matters, straight talk of control flaws, leading innovation and change, creation of viable paths toward sustainable development and economic growth. |
