Liquid speed: A micro-burst fee for low-latency exchanges

Abstract

A micro-burst fee on liquidity-taking orders reduces costs associated with latency arbitrage,while providing higher revenue for exchanges versus co-location subscriptions. The fee surges during activity bursts, as high-frequency traders (HFTs) simultaneously race to market. A higher fee limits burst intensity, which reduces adverse selection and narrows spreads. Unlike co-location fees, micro-burst fees scale with trading activity and allow exchanges to extract higher revenues from HFTs. To prevent exchanges from competing profits away, and provide long-run adoption incentives, a regulator needs to impose a (relatively slack) cap on micro-burst fees. A calibration exercise suggests that a micro-burst fee as low as 7.8 basis points per share could improve liquidity while generating higher exchange revenues than co-location subscription fees.If exchanges set the micro-burst fee at the RegNMS maximum cap of 30 basis points per share,our calibration suggests that liquidity would improve by 75%.