Risk

Tick-Size Pilot Cost Investors $350M: Study

"While the SEC's tick-size pilot was launched with the intent of helping investors and issuers, the outcome has been very different."
William SprouseSeptember 6, 2018
Tick-Size Pilot Cost Investors $350M: Study

Quantitative trading technology firm Pragma Securities said the tick-size pilot program for small-cap securities undertaken by the Securities and Exchange Commission will cost investors more than $350 million in reduced execution quality by the time it’s scheduled to end next month.

A report produced by Pragma and released on Thursday said stocks incurred excess trading costs of $300 million due to wider spread sizes and the increased implementation shortfall, which represents the difference between the price when a decision to trade is made and when it is executed.

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Investors trading stocks priced at less than $40 per share — representing more than 70% of the test group — incurred costs of more than $200 million, the report found.

“While the SEC’s tick-size pilot was launched with the intent of helping investors and issuers, the outcome has been very different,” said David Mechner, chief executive officer of Pragma Securities. “Concerns around execution quality and costs for investors were raised early on, and proved to be well-founded.”

Wider ticks (proposed in the Jumpstart Our Business Startups Act of 2012), it was argued, would also help small issuers by enabling broker-dealers to make money on providing liquidity in their stocks. Those broker-dealers would also have more money to spend on writing research reports on small-cap stocks, a critical piece of making a company’s shares more visible and attractive to investors.

While those expectations were not addressed by Pragma, there has been no evidence, anecdotal or otherwise, that the less-liquid issues involved in the pilot program have benefited in any way.

The SEC’s pilot began on October 3, 2016, and included stocks of companies with $3 billion or less in market capitalization, an average daily trading volume of one million shares or less, and a volume weighted average price of at least $2 for every trading day.

Under the program, the National Mark System created three test groups, of about 400 securities each, and a control group. The control group securities trade in the current increment of $0.01 per share, but the test group securities trade in increments of $0.05 per share under certain conditions.

Pragma’s study, which looked at orders from January 1, 2017, to June 15, 2018, found that the bid-ask spread in the test group’s nickel-spread stocks grew by an average of 31% versus the control. The average quote size grew by a factor of 10, but the average trade size was essentially unchanged.

“Bid-ask spread is a key market quality metric, but one of the theories at the start of the pilot was that a deeper quote might more than compensate for the wider spread,” according to Pragma. “[The results] suggest that the market did not see any benefit in the opportunity to trade in larger size to compensate for the wider bid-ask spread.”

Added Pragma: “Since the [tick-size pilot program] went into effect, market quality has significantly degraded for the test group securities in the ways critics of the pilot predicted prior to its initiation, and resulted in significant additional trading costs incurred by our clients, who represent pension funds, mutual funds, and other long-term investors.”

Given its findings, Pragma said, it “strongly” recommended that the tick-size pilot be unwound at the end of the pilot period.

Image: Getty

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