Multilateral trading facilities (MTFs) and exchanges are on the verge of igniting a tick size war that could decrease market efficiency and prove detrimental to investors searching for liquidity in European stocks.
Over the last two weeks, MTFs BATS Europe and Turquoise have both implemented finer tick sizes – smaller than those currently used by primary markets – for a select number of blue chip UK and Italian stocks. Both MTFs therefore have the ability to gain market share by making markets for these stocks just inside the spread of prices found on primary exchanges.
Today, the London Stock Exchange (LSE) responded by announcing its intention to reduce the tick sizes in which they offer trading in the 14 UK stocks for which BATS Europe and Turquoise have introduced finer pricing. Both the LSE – and Chi-X Europe – will introduce the new tick sizes on 22 June.
“By lowering tick sizes, venues are able to gain a slight competitive advantage by offering an improved bid/offer price compared to others,” Andrew Bowley, head of electronic trading product management at Nomura, told theTRADEnews.com. “If someone is willing to make markets on these tighter spreads, smart order routers (SORs) would automatically go to that venue to take that better priced liquidity and would also post more to those venues based on the higher volumes.”
Market observers have warned against the possibility of a tick size war in which reductions are used to wrestle back market share.
But Turquoise CEO Eli Lederman denies this is his MTF’s intention. “We did it because important members wanted us to and because we saw it as an opportunity to deliver significant price improvement in the specific stocks we selected,” he said.
Although finer tick sizes would result in less price volatility and a reduced risk of slippage when trading against a volume-weighted average price benchmark, Nomura’s Bowley notes that more price points would mean thinner liquidity, which could in turn lead to a reduced appetite for risk trades.
“Many risk trades are based on the bid/offer spread,” said Bowley. “If finer tick sizes result in more thinly spread liquidity, brokers will be less willing to make markets on the touch because of lack of available liquidity at a specific price point.”
“Thinner liquidity spread over a wider range of price points would mean more executions, resulting in higher execution costs, as well as creating more market data that would be increasingly complex to put together,” added Steve Grob, director of strategy at trading technology firm Fidessa.
BATS Europe teamed up with fellow MTFs Turquoise, Nasdaq OMX Europe and Chi-X towards the end of last year to devise a proposal for standardising tick sizes across Europe. The proposal was presented to the London Investment Banking Association (LIBA), which asked the London Stock Exchange, NYSE Euronext and Deutsche Börse to join the discussion on tick sizes. The exchanges then raised the issue with the Federation of European Stock Exchanges (FESE), which subsequently initiated a consultation process that included market users. The results of the exercise, together with a plan and a timetable, are expected on June 30.
The questionnaire proposes four potential tick size tables, with varying degrees of tick size increments depending on price range. For example, FESE table one has a tick size of €0.0005 for stocks priced between €0.50 and €0.9990, while FESE table two has a suggested tick size of
€0.001 for the same price bracket.
Turquoise has chosen to implement FESE table one tick sizes for 10 FTSE 100 stocks and five MIB 30 stocks, while BATS Europe is using the same tick sizes for 10 FTSE 100 stocks, five MIB 30 stocks and all the Swedish, Danish and Norwegian stocks in which it offers trading.
According to Lederman, Turquoise and the other MTFs have been ready to move forward for some time.
“The people working on this through LIBA were told by FESE that the exchanges also wanted to participate and since that time, the process has been set back by delay after delay,” said Lederman. “The market needs closure on this issue. The ball is now in the exchanges’ court and they will have to move very rapidly or they will get left behind. Ultimately, we prefer harmonisation on ticks, or there will be competition around the matter and it will be to the detriment of overall liquidity.”
During a LIBA conference call held on Tuesday, MTFs and exchanges, with the exception of Turquoise, agreed not to implement smaller tick sizes that those currently used, until the next meeting on 30 June.
Turquoise only agreed not to implement smaller ticks than those put forward in FESE table one and to give a week’s notice before any further changes. BATS Europe, which had implemented its new tick sizes prior to the meeting, encouraged the LSE to match their tick sizes in FTSE 100 and MIB 30 stocks. Turquoise has since announced that it will introduce FESE table one tick sizes for an additional four UK and three Italian stocks on 22 June to eliminate the previous difference with BATS.
“Our preferred approach would be to introduce any changes in a coordinated and coherent manner in the near future,” said the LSE in a service announcement. “Unfortunately, some other venues have pre-empted this process with uncoordinated, piecemeal changes of their own.
Consequently, we will be introducing similar changes as an interim arrangement.”
The fourteen UK stocks affected are: Anglo American; AstraZeneca; Barclays; BHP Billiton; BP; BT Group; Friends Provident; HSBC Holdings; Legal & General; Lloyds Group; Old Mutual; Rio Tinto; Royal Bank of Scotland and Xstrata.
According to Bowley, a member of the LIBA committee, the best solution for all parties involved would be the implementation of a single tick size regime as soon as possible.
“It would be better for the industry as a whole to agree on one tick size regime and keep it under a constant review through governance and a feedback loop,” he said. “We believe this should be settled together and quickly.”