A US tick size pilot program for small cap stocks may lead to outcomes unintended by regulators and legislators behind the plan, Paul Daley, head of product development for SunGard-owned algo developer Fox River, has said.
In a research note published this week by Daley, he stated that small- and medium- cap stocks share similar levels of liquidity compared with shares in companies listed in the S&P 500, and that certain types of buy-side firms would react differently to the wider spreads such a program would implement.
US regulator the Securities and Exchange Commission (SEC) will look to launch a pilot program for small and mid cap stocks as part of the Jumpstart Our Business Startups Act. In recent comments, SEC chair Mary Jo White has stated that if such a program were to proceed, it would occur outside of a planned holistic review of US market structure.
In February, the US House of Representatives passed a bill to modify a previous law to let companies with total annual revenue under US$750 million and a stock price greater than US$1 to be quoted with either a minimum tick of US$0.05, US$0.10 or their original minimum tick size.
In the research note, Daley shares Fox River calculations showing small cap stocks experience similar spreads to S&P 500 companies when adjusted for the amount of shares on offer.
“Based on [Fox River research], it would seem that Emerging Growth Companies are already as liquid as larger companies once you account for differences in the amount of shares available to trade,” he states in the research.
“Affected securities with tighter spreads will most likely suffer in volume and liquidity (particularly for the low priced stocks with narrow spreads) while stocks with already wide spreads have the potential to benefit,” he states, adding, “market makers for the stocks with narrower spreads will benefit at the expense of investors who wish to trade them,”.
He said investors would benefit or lose out with such a pilot program depending on their overall strategies. For instance, quantitative investors trading smaller sets of stocks across a diverse portfolio would be less inclined to trade in small- and mid-cap stocks compared to quantitative investors that buy large blocks in companies – including smaller-cap firms – based on proprietary research, as higher spreads would lower demand.
“A complete analysis of the impact of the law should include analysis of who were the winner and who were the losers in the process,” Daley added.