Many of the “tick constrained” securities are often subject to artificially wide basis point spreads due to the limitations of Rule 612 (c) of Regulation NMS, according to MEMX.
In its newly released white paper titled Market Structure Report: Examining Tick Constrained Securities, MEMX said these securities in aggregate make up about half of all volume and a quarter of trades and notional value executed on a daily basis in the U.S. equity markets.
“The time has come to update the rules that govern how these securities trade to eliminate this inefficiency,” said Adrian Griffiths, Head of Market Structure, MEMX.
He explained that Rule 612 of Regulation NMS, known as the “Sub-Penny Rule,” prohibits market participants from displaying, ranking, or accepting quotations in NMS stocks that are priced in an increment of less than $0.01, unless the price of the quotation is less than $1.00.
“The Sub-Penny Rule was designed to address the possibility of stepping ahead of displayed limit orders by economically insignificant amounts. While this is a laudable goal, it rests on an implicit assumption that what constitutes an “economically insignificant amount” is the same for all securities priced above $1.00,” Griffiths said.
“However, securities that trade below $1.00 (“subdollar securities”) are allowed to trade with a minimum increment of $0.0001 as this amount is considered to be “economically significant” for securities trading below $1.00, but somewhat confusingly not for securities priced at or just above this price,” he added.
When the SEC adopted Regulation NMS, it acknowledged that an exemption from the requirements of the Sub-Penny Rule pursuant to Rule 612(c) of Regulation NMS might be appropriate if, among other relevant factors, a security “always trades with a penny spread and there is tremendous liquidity available on both sides of the market.”
On August 30, 2021, MEMX submitted a request to the SEC for exemptive relief pursuant to Rule 612(c) of Regulation NMS requesting that the SEC permit market participants—including exchanges, alternative trading systems, and other trading venues—to display, rank, and accept bids or offers, orders, and indications of interest in an increment of half of 1 cent ($0.005) in “tick constrained” NMS stocks that trade with an average quoted spread of 1.1 cents or less.
The request for exemptive relief also asks for a commensurate 50% reduction in the access fee cap from 30 to 15 mils per share in securities trading at tick increments of less than 1 cent.
“We believe that such changes are needed and would facilitate both the needs of investors and the continued health of the U.S. equity markets,” Griffiths said that SEC Chair Gary Gensler has indicated a willingness to “freshen up” the SEC’s rules to better account for current trading realities.
“Getting tick sizes right will make trading more efficient in a large number of actively traded securities that currently trade with artificially wide spreads. That’s why we’re advocating for tick size reform as the SEC undertakes its upcoming review of equities market structure. We look forward to working with both the SEC and the industry on this important issue,” he said.
