Exchange operator NYSE Euronext and brokers Cowen Group Inc. and Knight Capital Group Inc. told a congressional panel they support a pilot program to increase the minimum-price increment for smaller, less-active stocks as a way of spurring trading.
Wider price increments would drive market makers to supply bids and offers for more shares, making it easier for mutual funds and other asset managers to buy or sell without moving prices, executives said. That, in turn, would boost investment in smaller firms, they said. The current minimum 1-cent increment is a one-size-fits-all approach that doesn’t make sense for all companies, according to Kevin Cronin, global head of equity trading at Atlanta-based Invesco Ltd.
The Jumpstart Our Business Startups Act, signed into law by President Barack Obama April 5 to boost job creation, requires the Securities and Exchange Commission to study how decimalization, or the shift in 2001 to 1-cent increments, may have affected initial public offerings and smaller companies. Yesterday’s testimony came in a hearing on market structure before the House Committee on Financial Services in Washington.
“We’d be very in favor of experimenting with allowing companies to select their own tick size,” Duncan Niederauer, chief executive officer of NYSE Euronext, told the panel. “Ultimately, you could argue that that could be their decision. I don’t think the implementation process would be long.”
Trading increments, known as ticks, of 1 cent are good for the 100 or 200 most actively traded companies, Cronin said at the hearing. For others, it “doesn’t seem to make a whole lot of sense,” and 5 cents or more may be better, he said.
“The more things we can do to enhance the liquidity and participation, the better,” Cronin said. “At the end of the day, it is our investors’ money that you’re looking to really get more engaged in this and one of the prices for admission for that is just more transparency, better liquidity.”
The business model in which dealers brought companies public, made markets in their stock and wrote research for investors began to wane a decade ago after regulators limited links between research and investment banking and decimalization changed the way companies trade. Profits from market making shrank as the spread between bids and offers narrowed.
That squeeze helped give rise to the proprietary and high-frequency trading firms who now account for more than half of American equity trading. Today, with markets fragmented across more than a dozen exchanges and electronic communications networks and more than 40 dark pools, venues rely on computerized firms to supply the buy and sell orders that make it possible for investors to quickly trade shares.
Boosting liquidity without significantly moving prices and providing more research would prevent companies from being “orphaned” once they’re publicly traded, Niederauer said. NYSE Euronext is in discussions with as many as 100 companies about accessing the capital market that it wouldn’t have been talking to if the JOBS Act hadn’t been adopted, he said.
The U.S. had 4,988 exchange-listed companies last year, down 28 percent from 6,943 in 1991, Jeffrey M. Solomon, CEO of Cowen & Co. in New York, said in written testimony that cited figures from the World Federation of Exchanges. Initial offerings that raised less than $60 million accounted for 74 percent of total U.S. IPO activity in the 20 years ending in 2000, while they were 24 percent over the last five years, he said in the testimony.
“If you can actually set your tick increment much wider, then the marketplace will react,” Solomon said today. “If you can set it wide enough and there’s profit incentive for middlemen to come in and make markets, then those middlemen will have an economic incentive to write research.”
Exchanges shouldn’t be “too prescriptive” about who should determine the tick size, Cronin said. Exchanges and investors may be in a better position to make decisions on the topic than management at companies going public, he said.
David Weild, senior adviser at Grant Thornton LLP, who oversees the company’s capital markets group and is a former vice chairman of the Nasdaq Stock Market with responsibility for corporate listings, said the tick size should vary from 1 cent to 25 cents based on the company. Firms with a market capitalization of less than $100 million should trade with a 25-cent spread, he said.
“If you want to commit capital, buy a block of stock and get, as we used to say on the trading desk, long and loud to go find a buyer, you need a way to get compensated for that risk,” Weild said.
The tick size in general should be adjusted based on the stock in question, Cameron Smith, president of Quantlab Financial LLC, a Houston-based quantitative trading firm, said.
“We need to calibrate” tick sizes to factors such as a company’s stock price, he said. “There’s no reason that Berkshire Hathaway should have the same tick size as some $5, very actively traded stock.”
Wider increments may not yield the benefits in companies going public and job creation that exchange executives and other brokers expect, according to Dan Mathisson, head of U.S. equity trading at Zurich-based Credit Suisse Group AG. He added that he wouldn’t object to the introduction of bigger price increments.
“It would not make a significant difference in the IPO markets or the ability to raise capital,” Mathisson said. “I do not think it would do any harm to the markets.”
Knight CEO Thomas Joyce said he supports wider tick sizes. The Jersey City, New Jersey-based broker, which makes markets in 19,000 publicly traded companies in the U.S., including about 6,700 on exchanges, has expanded as competing providers of liquidity pared back their businesses once profits came under stress because firms earned less money for each share traded.
“We have ended up with outsized market share because that business of making markets for small companies has become very tough and a lot of market participants walked away from the opportunity that we stayed with,” Joyce said. “If spreads widen, market makers might have an opportunity to have more of a profitable business.”
The number of market makers on Nasdaq has declined to 121 in April from 550 in April 1997, according to data published by the exchange. While the level shrank all but one year, the number of market makers per security has increased to 16.1 from 10.2 over the same period, according to Nasdaq data. The changes came in the wake of new trading rules for U.S. equities, a reduction in tick size and Nasdaq’s shift in 2006 from a dealer market to an exchange.
Wider spreads “may encourage more market makers to participate, more market makers to sponsor the stocks of the companies in question, more market makers to perhaps pick up research of the stocks and companies,” Joyce said.