Proposed Tick Size Pilot Draws Mixed Reaction

Terry Flanagan

The Securities and Exchange Commission and equities exchanges are working up a plan to test widening the tick size for smaller cap stocks, but it’s unclear whether such a pilot will be conclusive.

The main hypothesis of a pilot to widen the increment for quoting and displaying prices from the current one-penny size is that wider increments will lead to wider spreads, which will in turn motivate market makers to provide greater liquidity for an individual stock.

While narrower spreads are generally a positive result for investors, especially in more liquid securities, a one-penny minimum tick size for illiquid stocks may create a disincentive to provide liquidity at the best price, resulting in smaller quoted sizes and thinner markets.

NYSE Euronext has stated in position papers that a controlled pilot program to monitor the results of larger tick sizes in less liquid securities is worthwhile to observe whether it results in a positive impact on liquidity.

However, at the SEC’s decimalization roundtable in February 2013, Colin Clark, senior vice president at NYSE Euronext, said that a higher tick does not necessarily equate to a wider spread. “If you’ve got a stock that’s got a quoted spread of, say, seven and you move the tick increment to five, does the stock actually start moving to the five increment and actually narrow the spread, where you get some liquidity now aggregated at five and you get a lot of additional liquidity aggregated at 10, the net result being you’ve got a narrower spread and potentially more liquidity. There’s this tradeoff between spread and displayed liquidity that’s really at the core of this.”

“Part of the debate is whether there is enough benefit that it’s worth the effort of the industry to conduct a pilot,” said Joe Mecane, executive vice president and co-head of U.S. listings and cash execution at NYSE Euronext, at the Sifma Market Structure conference on Thursday.

An SEC advisory committee concluded that increased tick sizes for small-cap companies would increase liquidity in such stocks, and recommended that the SEC make the necessary rule changes permanent, without a pilot, stating that sufficient time would be needed for the rules to have an effect.

William Baxter, Fidelity

William Baxter, Fidelity

SEC chairman Mary Jo White has instructed SEC staff to work with the exchanges to develop a plan to implement a pilot program that would allow smaller companies to use wider tick sizes.

Buy side institutions are in favor of pilots with a well-defined set of metrics and measurements. “It’s important to isolate market microstructure changes and disentangle those from macro events,” said William Baxter, head of global program trading and market structure at Fidelity Investments.

“We are skeptical of the value of a pilot program with small cap stocks. With small cap stocks, the issue has less to do with decimalization than liquidity. Small caps aren’t correlated to broad moves in the market. For trading desks, it’s very difficult to find a hedge to offset your risk. Widening a spread to a nickel or dime won’t incent market makers to provide a significant amount of liquidity, especially for institutional investors.”

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