Wall Street Wary of Small-Cap Pilot


There are few times when the buy side, sell side and exchange operators are in consensus, but during the US Securities and Exchange Commission’s roundtable on thinly traded stocks, hosted by the Division of Trading and Markets, all agreed that no one wants another pilot.

The market-structure roundtable was the result of the Department of Treasury’s recommendation that the SEC look into the possibility of eliminating unlisted trading privileges to concentrate liquidity in thinly traded stocks to their listing exchanges.

The concept thrilled few attendees who saw many of the proposed fixes available but unused.

“Market forces already push liquidity for stocks with 50,000 share ADV to trade on 1.8 exchanges on average,” said Ovi Montemayor, managing director, financial markets services at TD Ameritrade.

Repealing UTP is a blunt instrument to address liquidity concerns and could lead to monopolistic practices, added Chris Concannon, president and COO of Cboe Global Markets.

“If I had exclusive listings, I would provide rebates to market makers and use an options model,” he said. “I might also increase my market data rates since you would need to come to my market for data.”

Even if the Commission eliminated UTPs without addressing off-exchange trading, its results would be limited, according to Concannon. “It would reward the exchange without providing a significant benefit to investors.”

However, the roundtable’s buy-side representatives did not want to place any restriction on their off-exchange trading.

Approximately 40% of Fidelity’s equities trading happened off-exchange from the start of 2017 to year-to-date, according to Brian Frambes, co-head global cash trading, at Fidelity Management & Research. “Of that, 10% happened on alternative tradings systems and 30% on TRFs,” he noted. “We do it to protect ourselves from information leakage.”

Dark venues need to be part of the discussion, he added.

Other suggestions included introducing additional call auctions to concentrate liquidity and alleviate temporal fragmentation.

“If a stock trades infrequently, the trader does not want to miss a print that may have 20% of the ADV,” said Brett Redfearn, director of the Division of Markets and Trading at the SEC.

Some auctions are very successful at concentrating liquidity, such as opening and closing crosses, but prove challenging in continuous markets, noted Stacey Cunningham, COO of the NYSE Group.

“The NYSE planned to introduce a mid-day auction a while ago, but the closer we came to its launch, more buy- and sell-side firms said they did not plan to participate,” she explained. “They did not want to leak information to continuous markets.”

Jason Vedder, director of global trading and operations at Driehaus Capital Management floated the idea of abandoning anonymity and returning to displayed interest for illiquid small-cap stocks. “We knew who the good market makers were and who were not, which allowed us to be a little more transparent,” he said.

The practice works well in Nasdaq’s Nordic Markets, according to Tal Cohen, senior vice president, North America equities, at Nasdaq.

But once again fear of information leakage keeps many broker-dealers from adopting it,” he added. “Why would I want to be out in front in public if 12 other exchanges would be trading anonymously?”

Despite the range of tools that the Commission can use to study the issue of thinly traded stocks, Joe Mecane, head of execution services, Citadel Securities, recommended that the regulator be sure on what it was trying to solve. “It sounds like an investment problem of not having a natural counterparty and trying to solve it with a market structure solution,” he said.

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