The SEC approved the NYSE Retail Liquidity Program today.  This proposal will allow the NYSE to route retail order flow to a group of privileged participants (High Frequency Traders), so they can provide retail price improvement (a fraction of a cent) to these orders.  The problem with this proposal is that this price improvement comes with a significant cost, it discourages displayed liquidity providers from placing limit orders.  I’ve outlined these concerns previously.

What incentive is there to display liquidity when there is a privileged participant that can step in front of your limit order at the moment it’s about to be executed?  This will lead to less liquidity in the LIT market, and eventually wider spreads.

The SEC’s rationale for approving this proposal is that virtually all marketable retail order flow is already internalized by OTC market makers, and this proposal is simply a way for the NYSE to capture some of that flow and participate on a more level playing field.

While we empathize with the NYSE, as they have lost significant market share to these OTC market makers, due to regulatory differences, it is our opinion that a better solution would have been to bring more transparency to the market by regulating those OTC market makers, as opposed to bringing less transparency to the market by allowing the NYSE to participate in the game.

Consider the following diagram of retail order flow:

Today’s decision by the SEC simply adds another barrier for displayed limit orders and retail market orders to interact.  We truly are losing our equity markets to the dark-side.

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