Michael Brolley

Liquid speed:

a micro-burst fee for low-latency exchanges

Marius Zoican

The cost of latency arbitrage

U.K.-based evidence (Aquilina, Budish, O'Neill, 2020) shows that latency arbitrage races are:

• Frequent: 537 races/symbol-day in FTSE100 stocks.
• Fast: winner speed margin of 5-10 microseconds.
• Concentrated: top 6 firms win 87% of races.
• Costly: A daily tax of 0.42 bps of total trading volume.
• Harmful for markets: Reduce liquidity for investors by 17%.

Existing market design solutions

• Focus on eliminating HFT races and improving liquidity.
• Not concerned with exchange revenues & incentive compatibility
• Sometimes at odds with current fragmented environment.

Micro-burst fees

Our solution: A micro-burst (congestion) fee

• Main idea: Surge pricing of speed (à la Uber).
• How? Implement a micro-burst fee on liquidity taking orders.
• Fee per message within sub-millisecond clusters.
• Fee level     # liquidity taking orders, surge during micro-bursts.
• Market price of speed: latency arbitrage is priced in.
• Mechanism produces revenue for exchanges.

A world with co-location fees

A world with no latency arbitrage

(e.g., idealized batch auctions)

Our proposal: A world with micro-burst fees

Micro-burst fee design:

Two parameters:

• A fee scale parameter
• The number of messages in the cluster

• Cluster size of 100 microseconds to 10 milliseconds).
• A fee of zero if a single marketable order in a cluster.
• Fees are computed intraday, but charged at low frequencies.
• Unlikely to accidentally pay fees: Daily race duration is 0.05s.

Game-theoretic equilibrium

Two important outcomes:

• Liquidity (    ):  the outstanding half-spread
• Race intensity (    ): probability of an HFT to race on a short-lived signal.

Impact of the micro-burst/congestion fee

Exchange revenues

Exchange revenues from micro-burst fees

How does the fee magnitude impact revenues?

• Direct effect:          implies higher revenues for each trade;
• Indirect effect:          reduces HFT incentives to snipe         less intense races.

How to optimally set     ?

Co-location fees lead to capped revenues

• Co-location fees do not scale with trading activity and

• they need to be paid in advance on all exchanges.

Micro-burst fee revenue > Co-location fee revenue

Precise fee shape is irrelevant for revenue

Competition and regulation

A fragmented exchange environment

• HFTs pay co-location fees on all exchanges:
  Profits are not competed away.
• With micro-burst fees, profits may be competed away since each exchange tries to capture the entire revenue.
• Solution: a (lax) regulatory cap on fees.

What is the incentive compatible fee cap?

Calibration

We calibrate caps on a constant fee structure:

• The revenue-maximizing fee is $0.34 per message.
• The regulatory cap is $3.98 per message.
• Any fee value in between:
  • generates higher liquidity than co-location fees
  • provides higher revenues than co-location fees.

How do micro-burst fee compare?