A drive by the nation’s largest stock exchange operators to win regulatory approval to trade stocks in sub-penny increments runs counter to the wishes of some of their biggest customers.
Money managers and their brokers are overwhelmingly opposed to trading in increments of less than a penny, the current minimum for stocks trading at $1 or more. They contend it will result in unfair competition for order flow as traders step in front of each other by insignificant amounts.
The firms and their representatives voiced their opposition in letters sent to the Securities and Exchange Commission in April, in response to suggestions in the regulator’s Concept Release that sub-penny trading be extended to low-priced stocks. Currently, sub-penny quoting and trading is limited to stocks trading at less than $1.
"Quoting in sub-penny increments would not contribute to the maintenance of orderly markets," the Securities Industry and Financial Markets Association told the SEC in a letter. "Sub-penny pricing would encourage market participants to ‘step ahead’ of competing limit orders by submitting an order with an economically insignificant price enhancement."
The Investment Company Institute, which represents mutual fund companies, echoed that sentiment. "We oppose any reduction in the minimum pricing increment for Regulation NMS stocks," the ICI wrote in its comment letter. Sub-penny trading could result in a "potential increase in instances of stepping-ahead of investor orders" and effect "market transparency and depth," the ICI added.
Individual brokerage firms also added their two cents. TD Ameritrade asked the SEC to ban all trading in increments of less than a penny, including in stocks trading for less than $1. In a survey, the big broker’s customers "demanded that TD Ameritrade request the Commission ban trading, printing and ranking of orders at a minimum price variation of no less than $0.01," Chris Nagy, in charge of order strategy and co-head of government relations, told the SEC.
Citigroup Global Markets told the SEC that "expanding sub-penny quoting would do more harm than good to the stability of the equity markets." In addition to stepping ahead, Dan Keegan, a Citi managing director, told the SEC, sub-penny pricing would increase the number of available price points, thus decreasing depth and "rendering the NBBO less effective."
The nation’s biggest exchanges have been promoting sub-penny trading since last year. They argue spreads are artificially wide in certain low-priced stocks, as witnessed by their trading volume and great size at the inside. The warped economics has driven much trading in these names to off-board venues where sub-penny trades can go up, the exchanges maintain.
In late April, the three biggest exchange operators–NYSE Euronext, Nasdaq OMX and BATS Exchange–decided they did not want to wait for the debate over sub-penny trading generated by the SEC’s Concept Release to play out. As the comment letters were flowing in, the three asked the SEC to make an exception to Rule 612 to allow them to trade 30 securities in increments of a half-cent over a six month trial period.
Under its exemptive authority, the SEC can grant their wish without public comment.
The exchanges do have their supporters. Firms that make markets on the exchanges see sub-penny trading as a way to recapture trades done off-board. EWT, a California-based proprietary trading firm, asked the SEC in a comment letter, to consider a "graduated increment scale" where stocks are priced in tenths of a cent if they trade for less than $2.
Hudson River Trading, a New York-based high-frequency shop, recommended the SEC "consider proposals to reduce the minimum price variation for securities that have artificially wide spreads due to the one cent minimum price variation."
