New equity listings can provide much sought after alpha and boost the wider economy, but regulators and politicians must be careful when crafting policy to encourage IPOs, such as tailored tick size regimes.
In what way do wider tick sizes encourage IPOs?
The core concept behind the idea that wider tick sizes will increase the number of IPOs is that institutional investors will be more willing to invest in small- and mid-cap names if spreads are wider, providing more liquidity and certainty that they will not be gamed by other participants at smaller increments. This, in turn, will encourage greater sell-side research on such firms, and, in turn, more will seek to list to fill higher buy-side demand.
In the US, tick size reform has leapfrogged other, potentially more critical issues facing the equity market. The Securities and Exchange Commission (SEC) has stated it wishes to act on tick size reform this year, and leave other reforms – addressing, for instance, high-frequency trading and the rise of off-exchange trading – to a holistic review. So far, a number of submissions have been made to the SEC on tick size reform, including a proposal from Citi that seeks to create three ‘buckets’ by which certain securities are subject to different tick sizes to generate relevant data ahead of any final SEC rule.
Has the experience and research generated so far in the US a positive sign for tick size reform?
Responses to the SEC’s plan to reform tick sizes have been mixed. In January, the SEC’s Investor Committee voted against pursuing tick size reform, arguing that it would not meet the stated intentions. Simply put, there is a concern from some market participants – including some asset managers – that wider tick sizes will have little or no impact on broker research in these companies or in the desire for such firms to list on public exchanges.
The obvious counter argument here is that this stage of tick size reform is a pilot program that will let the market decide and help regulators and participants alike make a judgment of its validity with hard data that is not currently available.
Research compiled earlier this year by Société Générale’s quantitative equities trading team on potential US tick size reform found that similar ventures in Japan and Europe had led to greater liquidity, but also a push into off-exchange trading as participants sought to execute at the midpoint rather than cross the wider spread. This sort of unanticipated effect of tick size reform would likely factor high in any SEC pilot program and is a hallmark of recent US equity regulation that policymakers and the regulator are keen to avoid – or at least adequately plan for.
What other market-based mechanisms could encourage IPOs?
It’s important to note the plan to reform US tick sizes is part of efforts to increase liquidity in the equity of small- and mid-cap names, not the broader spectrum of firms considering a public listing. For firms that sit both within and outside of this size category, going public will take into account wider market issues, such as the health of the economy and the proper functioning of US equity markets.
In this sense, stronger rules that provide further stability in public markets that have been plagued in recent years by low volumes (until 2013 at least), technology related failures, and the growth of segments seen by many as predatory – such as low-latency arbitrage trading firms – has had a net effect of reducing the attractiveness of a listing. These issues need to be addressed through sound, considered rulemaking based on relevant data to have any material effect on IPOs.