Europe’s buy-side remains divided over whether or not regulators should step in and mandate tick sizes for the continent’s exchanges, according to the results of February’s theTRADEnews.com poll.
Some 55% of respondents were in favour of regulation to impose the optimum tick size, while 45% objected.
At present, Europe’s exchanges and multilateral trading facilities (MTFs) follow the tick size regime set out by the Federation of European Securities Exchanges (FESE) in 2009. FESE’s tick size tables are not legally binding, but a “gentlemen’s agreement” among the region’s lit trading venues has ensured their predominance.
Those in favour of the current system suggest that the FESE regime accommodates the needs of differing groups of market participants and is informed by first-hand market knowledge that a regulator would not necessarily posses.
“We basically agree with the FESE tick size regime,” said Andreas von Brevern, spokesperson, Deutsche Börse. “We realise, however, that in some cases this regime is not consistently implemented. Therefore, we would speak for a regulatory solution should the FESE regime fail.”
Deutsche Börse chose to apply FESE tick size table four across the majority of its stocks, as did NYSE Euronext. By contrast, the SIX Swiss Exchange uses tick size table two.
Opponents of the FESE regime believe that Europe’s tick sizes are currently too small. Small tick sizes are conventionally viewed as a positive, since they help bring about narrower spreads by providing more scope for buyers and sellers to compromise on the price of a transaction. This helps drive up liquidity. But many observers suggest that the resulting depth of book is much shallower, because the available liquidity has been fragmented. This means it can be difficult and time-consuming to stitch together enough liquidity to get an order done.
“The tick size is too small,” said Martin Ekers, head of dealing at Northern Trust Global Investors. “It gets silly when you’re looking at half-penny quotes for a stock that you want to trade in millions. You get narrow spreads – for example, around three basis points – but you can only buy two thousand shares, not the million you want.”
Keeping pace
The solution proposed by some market participants is regulatory intervention, to set a mandated tick size across Europe’s exchanges and MTFs. This would then be reviewed once or twice a year, to ensure that the regime keeps pace with the evolution of the market. Agency broker CA Cheuvreux has already expressed hope that such a regulatory regime could be used to raise tick sizes, dampening high-frequency trading (HFT) participation in Europe’s equity markets and, in their eyes, reducing the pressure on long-term investors.
Research by Charles-Albert Lehalle, global head of quantitative research at CA Cheuvreux, suggests that small ticks attract high-frequency traders by providing them with more opportunities to jump the queue and get in ahead of long-term institutional investors. In addition, the high number of orders typically generated by HFT firms and then cancelled creates market noise that makes it difficult to discern real liquidity, critics argue.
“There’s a two-way pull when it comes to whether or not tick sizes should be set by regulators,” said Ekers. “My instinct is to say no to regulation, but the practical consequence of leaving this issue to the market is that it destroys the market structure by surrounding the quotes with too much noise – so I am in favour.”
Uncertainty over the effects of HFT on long-term investors in the lit markets has contributed to a flight of a significant portion of liquidity to Europe’s dark pools, which registered their highest ever market share figures (3.87% of total European equity turnover) in January, according to data provided by Thomson Reuters. So what is the solution?
“We need to strike a balance,” said Adam Toms, co-global head of electronic trading, Nomura. “It may be detrimental to the quality of pricing if ticks are too small, because the available liquidity on smaller tick sizes can be less. Pricing blocks off this limited liquidity could be difficult. I’d support regulation – so long as it is developed in partnership with market participants.”