One Year In, An Update On The Tick Size Pilot Program

By: Wayne Duggan

The SEC is now more than a year into its tick size pilot test program, and so far results have been a bit disappointing. The two-year program launched in October of 2016 and is part of the SEC’s efforts to make the stock market more liquid and less volatile.

Here’s a look at what the SEC is testing and the preliminary results of the effort.

The Test

In an effort to promote market liquidity, the SEC chose 1,400 thinly traded small-cap stocks to include in the test. All but 200 of the stocks included have been trading in five-cent increments rather than one-cent increments since the program launched a little more than a year ago.

Most retail investors have probably not even noticed the change, unless you’re day trading. All of the stocks included have market caps below $3 billion and average trading volume of less than 1 million shares.

The SEC is hoping to find evidence that forcing a larger spread in the test stocks will encourage brokers to make markets in the impacted stocks, which would theoretically improve liquidity.

Preliminary Results

Unfortunately for the SEC, reports of the progress of the tick size pilot have been mixed at best. “The pilot isn’t working,” Greenwich Associates president of market structure and technology Richard Johnson said earlier this year. “There are some who just think they should cancel it now. There’s even a question as to whether there is a problem with small companies.”

However, Mesirow Financial found at least some evidence of improved liquidity after six months. “Thus far, the program has led to a reasonable increase in market depth while increasing trading costs,” he wrote back in April.

A brand new study from the Centre for Economic Policy Research found that stocks included in the test group experienced “a reduction in liquidity” but “no significant change in liquidity risk.”

Where To Go From Here

Assuming the results are as disappointing as most third-party assessments suggest, the SEC may need to focus its efforts elsewhere if it’s looking to improve liquidity among small-cap stocks.

Bright Trading equity market structure analyst, and Benzinga PreMarket Prep co-host, Dennis Dick has said narrow spreads aren’t the biggest problem when it comes to small cap liquidity.
“They may need to look at internalization and the rise in dark trading volumes if they really want to improve market quality in the small cap space,” Dick said.

Dick said large amounts of small cap trading volume has migrated off the exchanges to Over-the-Counter market makers, leaving displayed liquidity providers feeling as if they are setting prices for stocks and assuming the risk while others siphon off their profits systematically.

The official results of the SEC tick size pilot program won’t be out until the exchanges and FINRA release preliminary assessments of the program.

Additional Reading: 5 Things You Need To Know About The New Tick Pilot Program.

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