Opposition and Controversy
The SEC approved the Tick Pilot on May 6, 2015 to assess the impact of wider tick sizes on liquidity and market quality of small cap stocks. Approval came after a lengthy comment period in which market participants submitted 77 comment letters. Debating the pros and cons of the plan to widen the minimum price increment from a penny to five cents, market participants criticized the tick pilot plan for its complexity and cost of implementation. Many market participants felt there was not enough cost benefit analysis done to justify the efforts.
“The controversy centers on what happens if certain participants choose to opt out of coverage of those symbols covered by the tick-size program. Market makers could say, “We‘re not going to participate in these names. We don’t want to be bothered with all the overhead. That is one concern,” comments Mindlin. “The second concern is that there’s a real dollar cost associated with implementing whatever is required to comply with the tick size program,” says Mindlin. One result is that because of the cost of implementing pilot programs, they often become permanent, “he says.
The premise behind the Tick Pilot is that wider spreads will allow market makers to earn more money every time they buy or sell a small cap stock. This, in theory, would motivate them to make markets in small cap names, underwrite more IPOs, fund more research coverage, all of which, in theory, lead to more listings by issuers, and improve capital formation.
But some industry professionals maintain the logic is flawed, and that wider spreads will raise costs for investors and that market makers today do not provide research.
The SEC’s own Subcommittee on Market Structure of the Investor Advisory Committee on decimalization and tick sizes in 2013 recommended that the SEC not reverse its decimal pricing policy. “That includes not engaging in “tests” or “pilot” programs,” wrote the subcommittee. “There is no evidence that if a larger tick size were adopted., any resulting increase in revenues for market makers would be used to support research or provide enhanced liquidity which would benefit capital formation,” wrote the subcommittee. Among the factors it cited were harm to retail investors.
“Many leading quantitative trading firms rely on their trading and technical acumen, and do not publish research on securities,” said Greg Ludvik, Director, OMS & Business Development at FlexTrade. “While a wider tick size should boost profitability for market makers in these securities, it does not necessarily follow that the provision of fundamental research will increase as a result.” In response to industry feedback, the SEC lengthened the pilot period to two years rather than one, reduced the definition of small cap securities from $5 billion to $3 billion, and decreased the size of a block transaction eligible for the exception. It also removed the venue restriction from the Trade-At component.
As it stands, the pilot will cover approximately 1,400 securities comprised of three test groups with 400 stocks in each group divided into “stratified samples,” plus a control group of the remaining securities. Pilot securities in the control group will be quoted at the current tick size of one cent per share, and traded at the current increments. Securities in the first test group will be quoted at five-cent increments but continue to trade at any price increment currently permitted. Securities in the second test group will be quoted at nickel increments and trade at those 5-cent increments subject to a midpoint quote exception, a retail investor exception and a negotiated trade exception.
Now that the tick pilot has been approved, firms are bracing for the next bump in the road. The tick pilot will impact the industry in terms of requiring data reporting and changes to systems and order routing.
Extensive Data Collection
On June 25, the Securities Traders Association (STA), the main trade group for brokers, hosted an open call to ensure the industry is aware of the deadline. An operating committee formed by the four main exchange groups and FINRA is developing an FAQ that will spell out the data collection requirements for Tick Pilot securities. According to the Intercontinental Exchange’s Brendon Weiss, who is chairman of the SRO Tick Size Operating Committee, Nov. 6 is the first milestone mandated by the SEC when everybody has to start collecting the data.
The operating committee is also gathering input from non-SROs, including a large market maker, a clearing bank, and a vendor to ensure that it understands each party’s needs. Weiss told listeners that the FAQ would be released in the next few weeks. There will be other FAQs pertaining to the trading functionality, but that will be Step Two, said Weiss.
According to Weiss, the data collection required under the Tick Pilot program is more extensive than current 605 reporting requirements and covers entities that are not currently covered by Rule 605.
Most brokers will be submitting the data to FINRA, according to the STA call. Some data will be aggregated and made available to the public, while other data will be kept proprietary and used by the SEC.
STA President Jim Toes noted that there are a lot of firms that are accustomed to collecting data, but there are some firms for whom this is not in their DNA and may require a new workflow. Exchanges, alternative trading venues and market makers already provide data for SEC Rules 605 about order execution and order routing practices.
Weiss said there’s nothing in the plan that prohibits a firm from outsourcing the data collection requirements to vendors. Having the vendors involved early on in the process will be helpful, he says.
But is the extensive data collection going to result in more liquidity for small cap stocks, IPOs and jobs?