By Adrian Griffiths, Head of Market Structure, MEMX
The cost of trading stocks for the average investor has never been lower. Largely commission-free, accessible and well-regulated, the U.S. equity markets are as efficient as ever. On June 9, new Securities and Exchange (SEC) Chair Gary Gensler outlined additional areas of focus for the Commission. Notably, Chair Gensler pointed to concerns that the National Best Bid or Offer, or NBBO, may not be a complete representation of all the information in the market. There are practical steps our fellow exchanges can take right now to address Chair Gensler’s concerns, improve the quality of NBBO, and lower trading costs for investors even further. A recent study conducted by MEMX shows that expediting round lot reform could reduce transaction costs by billions of dollars over the next few years, in effect putting money in the pockets of investors. What’s more, it’s a practical and easily implemented solution to our growing odd lot problem that is already supported by both the SEC and the industry. That makes it a great place to start as we look to improve markets for investors.
A “round lot” is the standard unit of trading for stocks under SEC rules and establishes the minimum number of shares needed to set bid and offer prices in the market. Almost all stocks currently trade with a 100-share round lot, and while this convention works well for most of those stocks, there are costly exceptions, especially in high-priced names. Today, an increasingly large proportion of trading in high-priced securities, such as Tesla (TSLA) or Amazon (AMZN), occurs in odd lot quantities of less than 100 shares. However, bids and offers in these smaller share sizes are not currently represented in the public quote. This means that investors that get their market data from the public feeds must often rely on information that does not account for the significant and growing amount of odd lot activity taking place within the spread. And, importantly, a wider spread between bid and ask prices included in the public quote generally results in investors paying more for the opportunity to buy or sell a stock. Narrowing these artificially wide spreads would save investors’ money — potentially billions of dollars.
The SEC has wisely recognized the importance of this issue and included round lot reform as part of a broad set of market data infrastructure changes to be phased in over the next three or four years. The new rules will base the number of shares that constitutes a round lot on the price of the security, reducing the round lot size to 40, 10, or 1 share for high-priced securities. But there is a long road ahead for the implementation of the SEC’s new infrastructure rule. That’s why we’re asking the listing exchanges to voluntarily make these important changes ahead of schedule. Making these changes now is the right thing to do for investors and based on our analysis may result in billions in transaction cost savings.
A quick look at the data shows that there are almost 200 high-priced securities that should trade with a smaller round lot size under the SEC’s amended rules. While these securities made up just 3% of shares executed and 8% of trades, they accounted for an outsized 29% of dollar value traded. Our analysis shows that these securities currently suffer from significantly wider spreads due to the higher notional value that must be risked to set the national best bid or offer. In turn, we estimate that lowering the round lot sizes ahead of time could result in up to $10 million in daily savings for investors, even when accounting for the fact that trading in high-priced securities often occurs inside quoted prices. With about 252 trading days in each year, it could cost investors up to $7.5 billion if the industry is forced to wait just three years for these round lot changes to go into effect. With this much at stake, we should act now.
While the SEC chose to give MEMX and the other exchanges more time to implement its new round lot rules that does not mean that we cannot or should not choose to go above and beyond for the investors that rely on the capital markets that we all steward. We hope to work with the primary listing exchanges and other national securities exchanges to make round lot changes now so that the industry and the investors we serve can reap its benefits without delay.
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Adrian Griffiths is Head of Market Structure at MEMX, a U.S. stock exchange based in Jersey City, New Jersey.
