January 26, 2010
Those Tricky Sub-penny Increments
Today's Wall Street Journal is reporting that the stock exchanges are seeking permission to alter the pricing parameters in place for nearly a decade. Specifically, SEC approval shall be sought allowing the market centers to price quoted/traded securities in sub-penny increments (e.g., $13.124) as opposed to the current penny standard (e.g., $13.12).
For decades, stocks traded at arcane, fractional levels only appreciated by trading professionals - 1/8, 1/4, 3/8. 1/2, 5/8, 3/4. At the insistence of regulators, these cryptic intervals were eliminated in favor of simple "penny" divisions that more accurately disclosed prices (and, ultimately, total costs) to the lay investor. Another prime consequence of the "decimalization" of April 2001 was reduced prices for that investor, as specialists and market makers were now forced to compete at prices "between the spread." Further, the NYSE reported a dramatic rise in system orders and trades. However, other ramifications included shorter-lived quotes, quotes with less depth (i.e., less stock offered at a price), and smaller trades.
The exchanges now argue that the loss of business to private trading systems (a.k.a. "dark pools") warrants another recalibration. The request is represented as responding to the concerns of institutional traders while also benefiting lay investors, who will once again see tighter price spreads at the exchanges.
The first consequence of sub-penny trading would surely be transparency, with investors breaking out calculators to confirm prices, charges and commissions. Moreover, in 2004, the SEC rejected a similar request for sub-penny pricing, stating:
...as the pricing increment for equity securities decreases beyond a certain level, the potential costs to investors and the markets may increase and could , at some point, surpass any potential benefit of permitting securities to be quoted in finer increments.
Regulation NMS Proposal, Release No. 34-49325.
A possible consequence of another modification would be loss of limit order protection, as firms hesitate to guarantee trade prices to customers in a rapidly changing market.
The SEC would likely study a request for sub-penny trading for many months. Overall, while "dark pools" and other private trading systems have taken their lumps during the economic crisis, it would seem that the exchanges have hurdles to overcome in seeking a further division of a trade price.
January 26, 2010 | Permalink