Introducing finer tick sizes for US equities could put a strain on long-only buy-side desks and give an additional edge to high-frequency firms, according to senior traders.
US exchanges, including the New York Stock Exchange and Nasdaq, are reportedly lobbying the US Securities and Exchange Commission (SEC) to permit them to accept quotes in increments finer than a cent.
Currently, exchanges can accept quotes in increments of a hundredth of a cent for shares trading below $1. But the exchanges are said to favour reducing the tick size to a tenth of a cent for stocks trading at or above $1 to allow them to compete more effectively with non-displayed trading venues.
“It is going to make my job harder, mainly because there will be a lot more volume traded, particularly by all the high-frequency shops,” Nannette Buziak, head of equities trading at ING Investment Management (Americas), told theTRADEnews.com. “The smaller increments will allow them to step ahead more to pick people off.”
The volume increases that are likely to result from smaller tick sizes could also tax the technology systems supporting buy-side desks. “It would place a lot of demand on all the technology to keep up,” said Buziak. “Average share prints will likely decline further. Market data channels are going to need to keep up because the amount of prints will go up enormously, as is FIX to be able to process all the fills.”
Robert McGrath, head of US equity trading at Schroder Investment Management, agrees that finer tick sizes could give high-frequency shops more opportunities to beat traditional traders to the punch. “The tenth-of-a-penny increments that NYSE and Nasdaq are talking about will make it a little bit cheaper for the high-frequency traders to continuously step in front of us,” he said.
The recent interest in amending tick sizes has in part been sparked by the ‘concept release’ published by the SEC on 14 January, which seeks market participants’ views on the functioning of the US market structure. In the release, the commission points out that the one-cent increment makes up a high proportion of the value of low-priced stocks, which may provide a greater incentive for broker internalisation of trades in these stocks. For example, a one-cent spread in a $20 stock is five basis points while in a $2 stock it is 50 bps.
The SEC paper also asks for participants’ views on whether, and why, wider spreads in low-priced stocks leads to more trading in dark pools and whether the regulator should consider reducing the minimum pricing increment for those stocks.
“When a stock is trading with a 25 or 50 basis point tick, there is a lot of room in there which makes for inefficient price discovery,” says Chris Isaacson, chief operating officer of US equities bourse BATS Exchange.
However, he adds, “We don’t believe finer increments are beneficial to every stock currently trading in penny increments. We would be in favour of looking at having different tick sizes for different price bands.”
Some warn that any lowering of tick sizes would require further changes. Reducing tick sizes to a tenth of a cent, for example would make them lower than the current access fee/rebate cap of 0.3 cents a share for shares trading over $1, meaning that the access fees would exert a greater influence over the total price paid for a stock than the quoting increment. This reversal could incentivise brokers to post increasingly aggressive quotes simply to pick up rebates. “You never want to have a case where your access fee is greater than your tick size, because then you have a best execution dilemma,” said Isaacson. “Access fee capping in the US would have to be reconsidered in conjunction with different tick sizes.”
Many assert that the tick size issue should not be isolated from the overall debate on market structure. “Quoting increment reform needs to be part of the conversation, but its impact on a wide variety of market structure principles and practices, including the competitive dynamic between issuers, investors and intermediaries, execution quality and other ramifications, needs to be examined,” said William O’Brien, CEO of ECN Direct Edge, which expects to achieve exchange status this quarter.
While some favour a partial change rather than an across-the-board amendment, even this may pose challenges for buy-side desks. “Overall you would still see an increase in volume and market data from where we are today,” said Buziak. “It will help a bit but it is not going to alleviate all the problems.”
Schroder’s McGrath says the potential impact on spreads is likely to overcome opponents’ objections. “I believe the change is likely because exchanges will argue that it will tighten spreads, which is effectively better for everyone. I don’t see how it won’t happen,” he said.
However, others point out that some US ECNs voluntarily stopped offering finer ticks because they enabled certain traders to jump ahead of others in the order queue by only offering tiny price improvements. Direct Edge’s O’Brien recalls that the BRUT ECN trading platform, where he previously served as chief operating officer, abandoned sub-penny increments in June 2003 because of customer feedback.
“It has been done before and ended up being essentially rejected, both by the marketplace itself and the regulators,” said Matt Cushman, head of quantitative research and trading at broker Knight Capital.