By John McCrank
NEW YORK, May 15 (Reuters) - A plan by the U.S. securities regulator to study how stock exchange pricing affects the market by creating different fee levels for different stocks and exchange-traded funds could stifle competition among ETF providers, industry executives told Reuters.
The U.S. Securities and Exchange Commission is preparing a one-to-two-year pilot program to test in part whether the way stock exchanges charge fees and pay out rebates prompts brokers to send customer orders to exchanges with the biggest rebates rather than those that would get the best result for clients.
The U.S. Treasury has backed the creation of the pilot as part of its overhaul of capital markets.
The plan will group most stocks and exchange-traded products (ETPs), such as ETFs, into four categories, each with different pricing schemes.
But including ETFs in the pilot is a mistake because, unlike stocks, many ETFs have similar or even identical underlying components, with providers competing more on things like having the lowest management fees, said Eric Pollackov, global head of ETF capital markets at Invesco's PowerShares.
"We are against the inclusion of ETPs in the actual pilot," said Pollackov, adding that his firm, the No. 4 ETF provider, supports the pilot for corporate stocks. "The playing field needs to be level when it comes to ETFs."
Under the pilot program, some stocks and ETFs will trade as they do today - with a 30 cent per 100 share maximum exchange execution fee, with rebates for resting orders left on some exchanges. Other securities will have a 15 cent per 100 share execution fee cap, while still others have a 5 cent per 100 share fee limit. Rebates will also be banned for certain securities.
That uneven pricing could create a problem for some ETFs. For example, there are multiple ETFs that track the S&P 500 Index, and one with a 5-basis-point execution fee would have a distinct advantage over one with a 30-basis-point fee. And an ETF that pays a broker a 30-cent rebate per 100-share order would have an advantage over one that cannot pay a rebate.
The SEC has not said how it will decide which securities qualify for which fee levels.
"ETF investors are keenly paying attention" to pricing structures, said David Lavalle, U.S. head of SPDR ETF capital markets at No. 3 ETF provider State Street Global Advisors.
He expressed concern about how the SEC pilot will impact similarly constructed ETFs, and market quality in general.
Some market participants have suggested the SEC ensure that ETFs of similar "flavors" end up in the same buckets, but that may be impractical given the scale of the industry. There are around 2,000 U.S.-listed ETFs offered by dozens of providers, with underlying investments ranging from tech stocks to junk bonds.
"You can't get into every esoteric flavor or the SEC is going to take a year to just try to get the buckets right," said Doug Clark, head of market structure for the Americas at brokerage Investment Technology Group.
The SEC declined to comment on the proposal, which is currently open for public comment. (Reporting by John McCrank; Editing by Lauren LaCapra and Rosalba O'Brien)