US stock exchanges and market participants will recommend a new tick size regime for less-liquid stocks at a roundtable hosted by the Securities and Exchange Commission (SEC) today.
The three-part roundtable is being held as part of the SEC’s mandate under the Jumpstart Our Business Startups (JOBS) Act, which was passed by Congress last April. Under section 106 of the act, the SEC was required to assess the US tick regime – the minimum increment in which stock prices can be quoted, which is currently set at US$0.01 for all equities.
The first panel will look at the impact of tick sizes on small and mid-sized companies and the potential economic consequences if the current regime was adjusted. The second panel will investigate tick sizes in the context of securities markets generally, while the third will examine the possible implementation, effect and monitoring of potential changes.
US bourses are largely in favour of running a pilot scheme that sets tick sizes for each stock based on liquidity characteristics and market capitalisation.
“We are supportive of running a tick size pilot that will offer the industry some measurable results that can be used to determine the impact on liquidity,” says Eric Noll, head of US and UK transaction services at Nasdaq OMX, adding that the current tick size regime was designed to let the market determine the appropriate bid-offer spread for a stock. “As liquidity has become more concentrated at the top of the capitalisation curve, there is a growing dearth of liquidity in small and mid cap names that needs to be looked at.”
For less liquid stocks that typically have wider spreads than blue-chip stocks, the ability to quote in pennies can mean the price at which market makers provide liquidity is undercut. This leaves market makers with unfilled orders, which are then re-priced with a wider spread and in less volume to reflect the added risk of not getting filled.
If tick sizes were increased – to a minimum of US$0.05 or US$0.10, for example – other trading firms would be unable to price their quotes inside of those already offered by market makers. Liquidity providers would therefore be rewarded for making a market and a greater amount of liquidity would coalesce around a single price point.
According to Cromwell Coulson, CEO of OTC Markets Group, a platform that matches order flow in small-cap companies, American depository receipts and non-US-listed stocks, a change in tick size should be accompanied by a minimum size requirement. At present, liquidity providers must offer at least 100 shares in stocks price over US$1.
“Without an approach that includes a larger minimum quote requirement, there is little incentive for market makers to provide liquidity in meaningful size,” said Coulson. “Investors need the ability to trade at the bid or offer in a decent size, otherwise they may feel as though the market is moving against them.”
Today’s roundtable is likely to look at the best way to organise a tick size pilot, which would probably be determined by the SEC in conjunction with market participants and stock exchanges. It could involve selecting a series of stocks with varying liquidity characteristics and applying tick sizes accordingly.
“We are seeing a declining amount of liquidity providers in SMEs, in addition to a dissatisfaction with SME liquidity by both investors and the companies themselves,” added Coulson. “We now have a great opportunity to experiment and then give listed SMEs a choice to opt in to a new tick size regime, based on the data that is collected through a pilot phase.”
Noll believes a final solution may include letting the listing market determine the appropriate tick size for a stock. But he also notes the need to ensure this approach is appropriately calibrated across markets.
“If stocks with similar liquidity characteristics listed on different exchanges have dissimilar tick sizes, we could introduce ‘listings arbitrage’,” he said. “In the first instance, this may require establishing a set of standards by which tick sizes will be determined.”