drew

For example, if a MM sees retail flow directionally tilted towards selling, they will quote their bid on-exchange lower than the NBB.

This has an effect on competition in the market making industry: other MMs without this data face disproportionately higher adverse selection when their orders execute at an NBBO price which is “crumbling” or otherwise quickly changing.

And it’s worth mentioning here that this factors into why there have been so few new retail equity MMs in the last ~20 years: MMs have to work to set up these relationships with retail brokerages and create commercial arrangements to buy flow.

The combination of the information advantage conferred by PFOF plus the duopolistic concentration in equities wholesaling means that the two largest firms in effect have strong knowledge of the direction of the NBBO, pricing others out of the business.

However, we should be clear that the information advantage does not equate to MMs “frontrunning” their clients, it merely means they are pricing differently than their competitors outside the NBBO and getting picked off at lower rates.

Anyway I hope this was helpful, I’m sure I made mistakes and typos as i wrote this in a few minutes after the twitter space. i also left out some deeper cases in the effort to stay brief and readable. anyway jump into the replies to yell at me all you want

Going to ask some naive questions. What data go into the "reference" price for a given security? Is there a concept in cash equities of a "primary" market (like in spot FX/cash UST)? Do dark markets price off lit? Does incremental volume done off market cheapen value of lit data?

1) assuming you mean the NBBO,“bid” and “offer” are defined under SEC Rule 600(b)(9) to mean the bid price or offer price at which an exchange or FINRA member is “willing to buy or sell one or more round lots of an NMS security.”