Five US exchanges have Retail Liquidity Programs (RLPs), which operate a limit order book only accessible to market orders from retail traders. In theory, this allows competition for segmented retail order flow. In practice, volumes executed in RLPs have been very low, and obtain prices inferior to those offered by off-exchange wholesalers, according to recent research.
Researchers from the University of Maryland, Carnegie Mellon University and Singapore Management University trace this failure to three distinct issues: (1) cream-skimming by wholesalers, so that retail trades in RLPs carry high adverse selection risk, (2) an inability by RLPs to display quotes without pre-trade transparency of available prices, and (3) a lack of trade-through protection, with wholesalers executing trades at prices worse than those offered by RLPs.
As the US Securities and Exchange Commission continues to consider new reforms for retail equity trading, RLPs offer critical insight into possible channels of competition for retail trades.
“We show that limited uptake of RLPs comes from three distinct forces: adverse selection of which retail flow is routed to RLPs, limitations on display of RLP liquidity, and a lack of quote protection for retail trades. While each of these failures reinforce each other, each is distinct and calls for a specific policy change…Wholesalers are currently limited in their ability to see what liquidity is available in RLPs due to the limitations on display of RLP quotes, in turn, this limits what nature of order flow wholesalers would be willing to route to RLPs,” the authors wrote.