Tick sizes have been more or less set in stone since they were standardised in a gentlemen’s agreement between European trading venues in 2009. Might a bit more competition offer a much-needed chance to boost liquidity?
Low European equity trading volumes have become a hot topic over the last few months. Uncertain macro-economic predictions may suggest market volatility will be a common feature in the medium term. But while volatility begets volume, could a little tick-size competition also provide equity markets with a shot in the arm?
The tick size is the minimum price increment for a stock on a trading venue. Once MiFID allowed competition between European trading venues, tick sizes became one of several differentiators, with new multilateral trading facilities (MTFs) using smaller tick sizes as a means to attract and compete for liquidity.
After a period of fierce competition encompassing trading fees and rebates, clearing costs and tick sizes, Europe’s exchanges, MTFs and brokers agreed on 30 June 2009 to harmonise tick sizes for blue-chip indices across Europe, using tick size-tables drafted by the Federation of European Securities Exchanges (FESE). The agreement whittled 20+ tick-size regimes down to two.
The tick sizes in FESE table two range from €0.0001 for stock prices of €0 to €0.4995 to €10 for prices of €10,000 or more. The tick sizes in table four are less variable across the price bands. Tick sizes of 0.001, for example, apply to all prices from €0 to €9.990, while tick sizes of 0.05 apply to all prices from €100 and above.
Some observers contend that smaller tick sizes have turned out to be one of the main benefits of MiFID, since (they insist) smaller tick sizes help create narrower spreads that reduce the distance both sides of a transaction must go to find each other. This helps to increase liquidity.
Sounds good. So what’s the problem?
Opponents dispute that the reduction in tick sizes really was the best outcome for traditional market participants. Some insist that the tick sizes agreed under the FESE regime are too small. A research document published by French brokerage CA Cheuvreux in January suggests that Europe’s low tick sizes actually harm market transparency, by attracting large numbers of high-frequency trading (HFT) firms that create market ‘noise’ that makes it difficult to discern true spreads and track real market activity.
HFT firms are attracted to venues with lower tick sizes because in theory, more ticks mean more scope for such traders to jump the order queue ahead of institutional traders, says Cheuvreux. The consequent lack of confidence in HFT-dominated lit markets on the part of some market participants may also have helped fuel increases in dark trading, which has increased its market share in Europe to record levels over the last 12 months.
In addition, some would argue that although tick sizes have narrowed spreads, they have also reduced the depth of book, meaning that there is less liquidity available to trade at any given tick size, thus making it harder to complete a block trade.
Should we increase tick sizes, then?
Not necessarily. As tick sizes increase, spreads tend to widen – potentially making it more expensive to trade less liquid stocks and thus dampening overall market liquidity.
While some see regulation to set the optimum tick size as the best answer, others insist that such a move is not necessary and could constrain Europe’s multilateral trading facilities and exchanges from being flexible in the face of changing market realities.
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