exchange member vs "direct access"

T

TD877

Still new to trading, have read a lot, but still can't figure out what might be a basic question to you all:

Why can't individual traders gain membership to exchanges? Why to gain "direct access" do we need to go through a broker (who charges commissions, and in the case of adding liquidity, take some of our rebates)?

I know you have to be a firm to gain membership to these exchanges, but do individual investors who can write their own server/client programs ever find ways around it? (e.g. Join a prop firm just for membership, not for capital?)
 
Because it's a regulated industry. (I'm going assume you are not talking about futures) To get direct access on your own with out a BD in the middle, you need to be a member of the exchange or hold a trading permit. To do that, you need to register with the SEC and a SRO (self regulatory organization). That way the SEC and the SRO have a way to monitor your activity and the way you do business.

Unless your business is substantial, your fixed costs from being a BD and having all your memberships in place will cost you much more than what these providers are charging you. You will still need a clearing firm that will also charge you fees. You need scale.
 
RMorse is completely correct; but I'd also add one other aspect to this -- it's called "clearing". Clearing is even beyond the domain of the exchanges (at this time, at least). At the top of the "clearing food chain", you have to use DTCC for stocks, or OCC for options. You're going to be on the hook for paying their fees, at least in the current framework, regardless of how much scale you've got. Even "self-clearing" broker/dealers (which are the really big ones with tremendous scale) need to go through DTCC/OTC, so it seems to me that "self-clearing" itself is a bit of a misnomer (but rmorse, please correct me if I'm wrong).

That said, some exchanges are supporting and/or working on "blockchain" technologies in an effort to revamp the current clearing system and thereby obviate the need for a traditional hierarchy of clearing. This will be interesting, although I doubt anyone really knows how it's all going to work out.
 
Occam said:
RMorse is completely correct; but I'd also add one other aspect to this -- it's called "clearing". Clearing is even beyond the domain of the exchanges (at this time, at least). At the top of the "clearing food chain", you have to use DTCC for stocks, or OCC for options. You're going to be on the hook for paying their fees, at least in the current framework, regardless of how much scale you've got. Even "self-clearing" broker/dealers (which are the really big ones with tremendous scale) need to go through DTCC/OTC, so it seems to me that "self-clearing" itself is a bit of a misnomer (but rmorse, please correct me if I'm wrong).

That said, some exchanges are supporting and/or working on "blockchain" technologies in an effort to revamp the current clearing system and thereby obviate the need for a traditional hierarchy of clearing. This will be interesting, although I doubt anyone really knows how it's all going to work out.
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Occam,

You can be a broker dealer but use a clearing firm for custody, clearing and banking. They take care of those other processes. You don't have to be self clearing to run an efficient trading operation. You also can use an execution broker to access DMA and avoid that fixed cost and still get a low variable cost with high volume. That means you pay a per share and per option fee for clearing/execution. The exchange you are member of will provide your own access but you need Access to the other exchanges too. Don't forget collocation, MD and cross connect fees

The problem is that you will still need a staff to met your SROs requirements even if you do no customer business. You need an exchange membership or trading permit. When I left the AMEX in 2010 my expenses would have been $10k per month for just me before I do one trade. Fees are higher now.

I would say today you need at least $5mm to get started. Maybe $10mm for the clearing firm that will be your guarantor. And, some have minimum commission per month of $10k.

Stick with your customer account.
 
As far as futures and options go, even if you were a full exchange member (and walk down on "the floor") you can trade directly but still need someone to clear you. In effect, vouch for your creditworthiness. Chase you down when you go bust and sell your seat and take your first born son. Tell you to lighten your exposure on all those naked puts. Exchanges don't go broke because they have clearing firms manage the credit risk of all members. Those clearing firms may or not take on retail or institutional accounts as well. I traded out of a private family clearing firm for a while, and they did it because they did a lot of spread trading and didn't want to pay all the commission that comes with spread trading, and also let the competition to know what they were doing. They handled their own lines of credit with the banks if there were any physical deliveries taken (god forbid, but mistakes are part of the business). It looked like a lot of headache but at least if a family member blew up there was some accountability.

If everyone cleared themselves there would be busted trades and no one would have confidence in the market that a trade is actually a real trade. You have to be big, reliable and answerable to the exchange and regulators if you want to clear yourself. I am not 100% certain about stocks, but how does the exchange know you are good for funds on T+3? Maybe you decided to bet it all on black and don't really have the money for $2 billion in apple stock? In effect, the exchanges have outsourced the work to third party to make sure people have confidence that their trade is real and will happen.
 
Ah, I knew it was heavily regulated but didn't realize the costs necessary were in the 5mm range. Yes, I'll be sticking with IB. Thanks for replying.
 
TD877 said:
Ah, I knew it was heavily regulated but didn't realize the costs necessary were in the 5mm range. Yes, I'll be sticking with IB. Thanks for replying.
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The costs are not $5mm. The requirement to open a BD account for a prop operation might be that high especially for options.
 
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