Market Structure Report: Examining the Tick Constrained Securities Issue
Why GE’s basis point spread was four times higher before its reverse split — and what we should do about it
There are almost one thousand securities that are consistently traded with a penny spread for virtually the entire trading day. Many of these “tick constrained” securities are actively traded by retail and other investors, and in aggregate they make up about half of all volume and a quarter of trades and notional value executed on a daily basis in the U.S. equity markets.
In a new whitepaper, we’ve analyzed the data around how these securities trade today and found they are often subject to artificially wide basis point spreads due to the limitations of Rule 612 of Regulation NMS (the “Sub-Penny Rule”). For example, the recent 1-for-8 reverse stock split of GE stock following the close of trading on July 30, 2021 clearly evidences how the current 1-cent tick size regime can bring artificially wide quoted spreads. With the reverse split, GE stock was no longer tick constrained and, as a result, the average quoted spread narrowed by 74% from 7.64 basis points on July 30, 2021 before the split, to 1.95 basis points on August 2, 2021 after the split, resulting in lower trading costs to investors.
While the reverse split improved trading in GE, it raises important questions about the costs of our current one-size-fits-all market structure as the tick size constraints that hindered trading in GE persist in many other U.S. equity securities.
On August 30, 2021, MEMX submitted a request to the SEC for exemptive relief pursuant to Rule 612(c) of Regulation NMS requesting that the SEC permit market participants—including exchanges, alternative trading systems, and other trading venues—to display, rank, and accept bids or offers, orders, and indications of interest in an increment of half of 1 cent ($0.005) in “tick constrained” NMS stocks that trade with an average quoted spread of 1.1 cents or less.
The request for exemptive relief also asks for a commensurate 50% reduction in the access fee cap from 30 to 15 mils per share in securities trading at tick increments of less than 1 cent. Ultimately, we believe that such changes are needed and would facilitate both the needs of investors and the continued health of the U.S. equity markets.
SEC Chair Gary Gensler has indicated a willingness to “freshen up” the SEC’s rules to better account for current trading realities. Getting tick sizes right will make trading more efficient in a large number of actively traded securities that currently trade with artificially wide spreads. That’s why we’re advocating for tick size reform as the SEC undertakes its upcoming review of equities market structure. We look forward to working with both the SEC and the industry on this important issue.