This October brought the initiation of the tick size pilot from the Securities and Exchange Commission
that was prescribed by the JOBS Act in 2012. The goal is to improve after-market support to small- and micro-cap stocks. There remains plenty of debate over whether the method will ultimately prove successful. While it's too early to draw any firm conclusions, we are beginning to see what some of the effects of the pilot may be for the affected stocks.What's happening?
The SEC approved a proposal by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) for a two-year pilot program that would widen the minimum quoting and trading increments – or "tick sizes" – for stocks of some smaller companies, expanding them from $0.01 increments to $0.05.
The tick size pilot rolled out in October 2016 included stocks of about 2,600 companies with:
$3 billion or less in market capitalization
An average daily trading volume of one million shares or lessA volume weighted average price of at least $2 for every trading day
Data generated during the pilot will be released publicly, allowing experts to assess whether the goal of improving markets for smaller public company stocks was met or not. The exchanges and FINRA will submit their initial assessments on the tick size pilot's impact 18 months after the pilot begins using data from the first 12 months of operation.
Potential for Benefits to Employee Equity Programs
Small-cap companies are by far the greatest drivers of jobs growth. So, can changing tick sizes move the needle for the small-cap companies out there?
The thinking behind the pilot program is quite simple: larger tick sizes mean more profits for market makers and broker-dealers trading in those stocks, giving them more reason to support that segment of the market.
"The small company may have no equity research coverage from either the buy or sellside, as Wall Street loses money covering small company stocks," said David Weild, founder of Weild & Co. in a previous interview with Equities.com
When tick sizes were larger, Weild said, there was a clear motive to try to help investors find small-cap stocks.
"Market makers ... would buy at the $10 bid and sell at the $10.25 ask price, booking a handsome 25 cent profit," he continued. "As a result of these rich incentives, market makers deployed quite a bit of capital to support the 'asymmetrical' trading nature of small company stocks and make them trade 'symmetrically' … These small-cap markets were liquid and profitable, and so Wall Street invested in them with research, broker sales attention, and capital commitment. This attracted investment dollars from sophisticated institutions, which caused stock prices to rise and more companies to go public."
As such, if the program is successful in improving the amount of available research and increasing liquidity for these securities, it could provide a major benefit to the ability of the companies they represent to grow. A liquid, tradable stock helps a company navigate capital markets and establish a stronger line of credit, not to mention potentially go to public markets to raise funds.
What's more, for many smaller companies, stock option programs can be an essential piece of their compensation package, making a more liquid stock a key factor in recruiting talent. That's one of the areas of focus for Sajoo Samuel, Senior Vice President and head of product development for U.S. Equity Services with Computershare
. Computershare works with transfer agency and employee equity plans, among other services, and Samuel could see where success for the tick size pilot could have material benefit to smaller companies.
"Any time you create greater liquidity, the stock options programs could benefit from it automatically," says Samuel. As for where the pilot is currently, Samuel said, "it's too early to call, but I assume that investors are getting the benefit from the additional liquidity in the market.
Skeptics Remain for Tick Sizes Pilot Program
"I was not a big fan," said Tabb of the pilot. "I don't agree with the premise (widen spreads and create more jobs). I think the idea that if you widen spreads the additional revenue generated by those wider spreads will be invested in research and create incentives to take more mid- and small-cap companies public isn't right anymore. Market-making firms have no ties to research and underwriting these days."
As for the pilot, Tabb was also displeased with its execution:
"It is over-engineered with a number of moving parts," he said. "The third group with the 'trade-at' rule is especially taxing. Millions of dollars in technology and testing with unknown benefits. The other 2 pilots are less technologically challenging. That said – 2 years should be enough time to see if this works or not."
However, there are signs in the initial data on the pilot that point to clearly discernable difference between the test group and the control group, even this early in the program. Australian firm CMCRC
captures global trading data and has been tracking the differences in a number of different metrics
with regard to the pilot.
The initial results there are a mixed bag, with more exchanges spending more time trading at the NBBO and spreads increasing, but without a significant increase in volume or in the number of investors participating in the small-cap market. It remains very early in the pilot, so it's entirely possible all of this may change.
When asked for an opinion on the results of the tick pilot thus far, the SEC responded with no comment and the New York Stock Exchange didn't respond to the inquiry.
Too Early to Tell
It does remain entirely too early to draw any meaningful conclusions. It may take some time yet before broker-dealers, market makers, and research firms begin to take meaningful action in response to the pilot program. With two full years planned for the pilot program, there's ample time for real changes in buying behavior to settle in.
As such, while the earliest data is clearly of interest, it doesn't appear to show enough of a difference one way or another to draw any major conclusions. Before anyone can say with certainty whether changing tick sizes will create the desired after-market support, there needs to be enough time for market actors to actually change strategy to respond to the pilot, which will likely take more time yet to materialize.