Institutional investors unhappy with tick size pilot

October, 2017

The US Securities and Exchange Commission should consider ending the failed Tick-Size Pilot in small-cap stocks early to free up time and resources for other experiments in equity market regulation, such as the proposed Access Fee Pilot Program, stock exchange “speed-bumps” and reforms or even the removal of the Order Protection Rule (OPR).
 
That is one key takeaway of a new report Investors’ Take on Market Structure Issues—2017 from Greenwich Associates. The report presents the findings of interviews with 52 US buy-side equity traders about changes in market structure.
 
Tick-Size Disappointment
Institutional investors view the Tick-Size Pilot as a failure. The two-year test program was launched by the SEC in 2015 with the hopes of increasing market liquidity. Almost one-third the traders feel so negatively about the tick-size pilot that they think it should be discontinued immediately. “It’s time to clear the deck of the tick pilot in order to focus on other topics,” says Richard Johnson, Vice President of Market Structure and Technology at Greenwich Associates and author of the new report.
 
Speed Bumps
If anyone thought the matter of “exchange speed bumps” was settled when the SEC approved the speed-bump equipped IEX last June, they were mistaken. That decision approved the IEX’s use of a coil of cable that introduces a 350 microsecond delay on orders going into and out of their matching engine said to take away the speed advantage of high frequency trading firms.
 
Other exchanges, including the Chicago Stock Exchange have proposed variations on this approach. Currently, the market is divided, with three-quarters of traders in favor speed bumps, but 30% supporting the IEX model only. “This is not even a close call,” says Richard Johnson. “If regulators have decided that speed bumps are a permissible part of market structure, then other exchanges should be free to implement their own versions, subject to regulatory approval.”
 
Maker-Taker Pricing

Two-thirds of the equity traders in the Greenwich Associates report believe that “maker-taker pricing” creates distortions and is bad for market structure. In maker-taker pricing typically a rebate is provided to participants for adding liquidity to an order book and an “access” fee charged for removing liquidity. Many buy-side traders also think regulators should go farther and ban rebates altogether.
 
Order Protection Rule: An Obsolete Requirement?
When it came into force in 2005 as part of Reg NMS, Rule 611, or the Order Protection Rule (OPR), was very popular. Today brokers and institutional traders employ sophisticated algorithms and smart order routers, venue analysis and other analytic tools making this Rule unnecessary. Removing OPR could reduce complexity, fragmentation and the benefits of speed, while opening the door to innovative products.
 
“We believe the OPR is likely obsolete,” says Richard Johnson. “We would be supportive of a pilot which could quickly assess the effect on liquidity and execution performance.”