KCG Sees Costs in SEC Test to Improve Small-Cap TradingSam Mamudi and Doni Bloomfield
KCG Holdings Inc., one of the largest stock market-makers in the U.S., said a plan to increase trading in small-company equities is likely to hurt most investors.
The U.S. Securities and Exchange Commission last month announced a pilot program to examine whether to price some stocks in minimum increments exceeding the current 1 cent. A study by KCG, to be released today, argues that the experiment will increase costs and complexity for investors and could make trading speed an even more important factor in the equity market.
KCG joins rival Citadel LLC and others in expressing doubts about the regulator’s proposal. Earlier this year, firms including Travelers Cos., Pershing Square Capital Management LP, and D.E. Shaw & Co. advised against conducting a test. Defenders say that increasing the spread between prices to buy and sell smaller stocks will spur more trading of the market’s least-loved companies and lead to more initial public offerings.
“Transaction costs are almost certain to go up for institutional investors,” Phil Mackintosh, head of trading strategy and analysis at KCG, wrote in the study.
Under the rules put forward by the regulator, shares of lightly traded companies with market values below $5 billion may only be quoted in five-cent increments, or ticks. Supporters of the program, which would last a year, say it will encourage market makers that facilitate trading to buy and sell more shares and create conditions that would persuade more companies to go public. Opponents of the change, including Fidelity Investments, say it will cause investors to pay more when they buy the shares of small-cap companies.
SEC spokesman John Nester declined to comment on the study.
Mackintosh also said the part of the proposals that force trading onto public exchanges and away from broker-run platforms such as dark pools, known as a trade-at requirement, is flawed. Pushing executions to a lit market without addressing issues such as exchange pricing and rebates and the various order types “will make it difficult to draw actionable conclusions,” he said.
KCG operates three liquidity pools, which between them saw an average of more than 100 million shares change hands daily in May, according to latest data from Rosenblatt Securities Inc. Its market-making business saw pre-tax earnings of $76 million in the first quarter while the firm’s overall pre-tax earnings on a continuing basis were $59.4 million.
“It’s simply too early to determine how the results of the proposed test affect our business,” Sophie Sohn, KCG spokeswoman, said in an e-mail. As well as its off-exchange business, KCG has a booth on the floor of the New York Stock Exchange and is a designated market-marker in more than 1,500 NYSE-listed symbols, she said.
Mackintosh said that while the wider price increments should increase the volume of offers to buy and sell shares at the best price, it could also make the stock market faster.
“It will be that much more important to be able, as the market picks up one of these five-cent ticks, to be the first guy at the new offer,” he said by phone. “So latency is actually going to be more important than it is right now.”
The KCG study is another skeptical voice in the debate about whether widening price increments is the best way to improve trading. Earlier this year, an SEC advisory committee that included executives from Pershing Square, Travelers and D.E. Shaw voted to encourage the agency to drop plans for the test. Last week, Ken Griffin, chief executive officer of Citadel, said at a Senate hearing that he opposes the SEC plan.
Supporters of the test include members of the Equity Capital Formation Task Force, which sent a report recommending the pilot program to the Treasury in November. NYSE and Nasdaq OMX Group Inc. are part of the group.
Mackintosh said KCG will publish a second report looking at ways other than the SEC test to improve trading in small-cap stocks. One suggestion would be for those companies to split their shares, he said, which would increase their price increments on a relative basis.
“It would trigger the same thing in the sense that it would make the spread wider in basis points,” he said, referring to fractions of a percent.