By John D'Antona

Brokers Gear Up for Tick Pilot

Wall Street brokers are getting ready to comply with the latest pilot program from the U.S. Securities and Exchange Commission.

The equity market is about to embark upon a two-year program to evaluate the possible benefits or hazards in trading different securities in different tick sizes. The so-called Tick Pilot program is targeted at smaller-company stocks that are using harder to trade at the current penny increment that most stocks trade at. The idea behind the pilot is to incentivize broker-dealers to make markets in smaller stocks, and to encourage the brokers to provide research in these less liquid stocks.

“This is finally going to address the notion that one tick size does not fit all,” said James Angel, associate professor at the McDonough School of business at Georgetown University told Markets Media. “Having one tick size for all stocks is like charging the same price for different cars. It just doesn’t work.”

And the SEC agreed. In October 2015, the Equity Market Structure Advisory Committee set up the protocol for the Tick Pilot program by setting the timeline for the pre-data collection phase which began in April. The full pilot is set to begin on Oct 3 and last for two years.

In the pilot program there will be three test groups, plus a control group. One of the groups will include at “trade at” component. The program will allow trading in larger than penny increments in 1200 small/mid-cap securities with market caps of less than $3 billion and have an average daily trading volume of less than 1 million shares. Share price for the stocks will have a closing price and VWAP price of $2.

Also, only limit orders sent in nickel increments in these securities will be accepted by exchanges and brokers (exceptions for retail, midpoint, and negotiated trades). Stop prices must also be sent in nickel increments. Lastly, the rounding of non-nickel orders to the nearest nickel increment by brokers will not be permitted.

According to Stephen Luparello, Director of the SEC’s Division of Trading and Markets two of the exchanges have already communicated they have defined some of the pilot’s stocks and collected data.

And now the brokers are ready for the pilot program. In an interview with Markets Media, ITG’s Scott Kurland said his firm was ready to go. He noted that the responsibility ultimately falls on the executing broker or market center to reject orders in non-nickel increments, or there could be significant workflow impact for buy-side traders.

“There could be rejects on select orders out of a list that may throw off rebalances, program trades, pairs trades, or portfolio trading activities,” Kurland said. “Traders must pro-actively monitor for rejects and then adjust and resubmit prices in nickel increments accordingly.”

To help its clients with the new workflow surrounding the pilot, Kurland said that its Triton execution management system has been altered to reflect the new pilot regime. First, Triton now highlights in a special column whether or not a security is in the pilot. The system also sends an alert to a trader when a limit price violates the tick size parameter or when an OMS system sends an order in with an invalid target price. Other highlights include that all limit price types will adhere to the nearest tick and a “hot button” that a trader can press that will automatically round pilot security prices with invalid target prices to the nearest tick.

“We’ve decided to get in front of the pilot and tick or check all the boxes and get ahead of this,” Kurland said.

ITG will also be releasing a white paper in September further detailing just what traders might expect in the Tick Pilot as more details are announced. The firm also plans to do some TCA work around the pilot after sufficient preliminary data has been gathered.

A third paper is expected examining the tick size pilot with regards to trade cost analysis.

Portfolio traders could see particular trouble, he added, as these participants who trade lists or programs, or are doing a rebalance that includes multiple securities across the capitalization spectrum could see some of their orders or even the entire list, if not priced in the appropriate tick increment, rejected.

“Essentially any strategy that trades with a specified limit price or is based off a model could see a problem too,” Kurland said. “The trader then has to manually go back and fix the invalid prices or manage the rejected orders.”

Pairs trading could be affected too, he added

“Anybody who has created a custom limit price or order, if not in the right increment, will have a problem,” he said. “we’ve gone through these scenarios and tried to proactively address these issues further upstream in the EMS prior to order release and exposure.”

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