Last week’s move by the Securities and Exchange Commission (SEC) to reduce the minimum tick size of many national market system (NMS) stocks to half a cent marks a significant milestone for the US equity market.
Alongside the tick price reduction, the SEC voted to reduce the access fee caps for protected quotations of trading centres, increase exchange fee and rebate transparency and accelerate the implementation of rules obliging exchange to provide timely information and certainty of fees and rebates at the time of execution.
As such, this week’s announcement has been something of a double-edged sword for exchanges. On the one hand, changes to minimum pricing increments could help to draw traders back to executing on exchange. On the other, reductions to access fee caps – 0.1% of the quotation price per share for stocks under US$1, down from the current 0.3% level – could put a dent in their earnings.
However, estimating such impacts is not straightforward. Nasdaq’s cash equities business saw US$703 million in trading revenue in the first half of 2024, which drops to just US$212 million after deducting expenses, rebates and fees. At ICE, which owns NYSE, cash equities trading revenue net of transaction-based expenses was US$151 million in H124. By comparing this to equity options revenues, Global Trading estimates that ICE made US$935 million gross revenue from cash equities over the first six months of the year.
While observers agree that exchange revenues will be negatively affected, people familiar with the exchanges caution against applying the two-thirds reduction in fee cap directly to their disclosed numbers. Only part of the cash equity revenues is covered by the fee cap, and this is not disclosed by the exchanges. Moreover, opacity in the way the exchanges allocate rebates to liquidity providers means that changes to the fee cap might not feed into revenue changes in a straightforward way.
While both ICE and Nasdaq declined to comment on the impact that the change would have on their profits, Nasdaq was scathing about the overall impact on the market: “The latest rules will impose serious harm to the long-term strength of the U.S. equity market, weaken the NBBO (National Best Bid and Offer), and ultimately increase costs for investors and listed companies”, a spokesperson told Global Trading.
Why now?
Commenting on the proposals, SEC Commissioner Caroline Crenshaw explained the rationale behind the change. “Currently, many exchanges charge the maximum fee and then pay out nearly all of it as a rebate to compensate liquidity providers. Though the
exchanges retain a small amount for themselves, this practice distorts the price that is actually available to investors. Therefore today’s amendment, which reduces the access fee, will allow exchanges to retain that same net capture for executions they were already keeping and continue to use rebates.”
That said, this is an experimental approach; “Reducing the distortions in the market associated with the fee/rebate models that have developed under the higher access fee cap should help improve market quality and preserve the integrity of displayed prices, which will reduce costs for investors,” Crenshaw said. However, she added, “It remains to be seen whether it will be helpful enough”.
The amendment to tick sizes has been long-awaited. Rule 612 of Regulation NMS, adopted by the SEC in 2005 “to modernise and strengthen the national market system for equity securities”, stated that the tick size NMS stock with a quotation, order or indication of interest priced at US$1 or above cannot go below US$0.01. Stock priced below this threshold were given a minimum pricing increment of US$0.0001.
A changing world
Since rule 612 was introduced, now almost two decades ago, “there has been a marked increase in trading volume related to NMS stocks that are constrained by the minimum pricing increment under the rule”, the SEC said on Wednesday. Tick-constrained stocks, with a time weighted average quoted spread of US$0.011 or less, make up the majority of the current trading volume, the commission reported in its proposal, and are unable to be priced by market forces. This causes the artificial constraint of their pricing, it continued, due to large quoted spreads.
Stocks become tick-constrained when their price is a low dollar amount (like Intel), in which case the tick size will end up being the spread of that stock as well. That increases trading costs for tick-constrained stocks, particularly for those who trade them frequently, and has led many traders to execute their trades off-exchange, on venues subject to less strict regulation. As much as two thirds of volume for large-cap stocks like Nvidia, for example, are executed on Finra’s Alternative Display Facility.
As commissioner Mark Uyeda explained, “if a tick size is too large, it can discourage price
competition on national securities exchanges and cause market participants to seek out other venues that might lower transaction costs.”
“The market structure and technology available today is vastly different from what was available when Regulation NMS was adopted”, the rule-change proposal said, drawing attention to the rise of electronic trading and the speed at which it can handle and process information. In light of this, “investors should have access to the best priced quotations available in the national market system and such prices generally should be determined by competitive market forces”.
Commissioner Crenshaw, in a statement on the amended rules, said: “Data analysis has shown that it would be easier and less costly for investors to transact in these stocks if they were allowed to quote at increments smaller than one penny.”
Through the revisions the SEC hopes to ensure that orders placed in the national market system reflect the best prices available, reducing transaction costs and improving overall market quality.
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