Securities regulators seek to improve liquidity in small-cap markets

Securities regulators seek to improve liquidity in small-cap markets
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U.S. market regulators are embarking on a two-year test to see whether widening quote spreads will boost liquidity and aid new publicly traded stock offerings in the small-capitalization market. 

The “Tick Size Pilot” (TSP) program, submitted by the National Securities Exchanges and the Financial Industry Regulatory Authority and approved by the Securities and Exchange Commission Oct. 3, will widen the increments at which small-cap stocks — those valued under $5 billion with share prices greater than $2 — are priced, to $0.05 from $0.01.

In so doing, regulators hope to increase market-making profits, boost liquidity and investor interest in small-cap stocks and their Initial Public Offerings (IPOs).

Jim Toes, president and chief executive officer of the Security Traders Association, told The Hill Extra that the pilot program isn’t the “end-all, be-all,” but should help address liquidity issues in a vital part of the economy.

“If you don’t have a strong secondary market, then you’re not going to have a strong IPO market,” he said. “From there, this is where all the jobs get created.

“The data is pretty strong, four years after going public, how their employment ranks grow. … It’s a significant number,” Toes said.

Three test groups

The pilot program will consist of a control group and three test groups comprised of roughly 400 securities each. The control group securities will be quoted and traded at their current tick size. All three test group stocks will be quoted in $0.05 increments, but other details between the groups will differ meaningfully. 

Test group one will continue to trade in its current increments. Test group two will be quoted and traded at $0.05 but will allow exemptions for midpoint and retail investor executions and negotiated trades. 

Group three includes what is considered the most controversial measure — the trade-at rule. The trade-at measure would likely push more trading from private venues, like dark pools, to public exchanges by prohibiting brokerages from conducting internal trade executions unless they can guarantee a substantially better price than what’s available publicly.

Trade-at troubles

Larry Tabb, CEO of capital markets research firm Tabb Group, said he would have limited the pilot program to test groups one and two.

“I probably wouldn’t have gone with the trade-at [rule] because it adds a lot of complexity, programming and testing issues, and given we’re talking about illiquid stocks, you’re investing a lot of money in stocks that don’t trade very much,” he said. “So, there are questions as to whether that will ever pay itself off.”

Eric Noll, president of brokerage service provider Convergex, said in a written argument that while he is skeptical the Tick Size Pilot program will accomplish its main goal of boosting liquidity in the small-caps space, he believes it will provide overarching benefits to markets.

“The program should, however, make useful contributions to a broader assessment of U.S. equity market structure, especially as it relates to clustering reliable, stable and tradable liquidity,” Noll said. 

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