Earlier this week, STA filed what will most likely be its last comment letter on the Tick Size Pilot. Our letter offers opinions on the upcoming termination date and the assessment of data accumulated during its first twelve (12) months, which can be summed up in a single sentence:
“Based on the empirical data captured in the assessment and our members’ experiences as practitioners, STA recommends that the Commission terminate the Pilot in its entirety and return all securities to their pre-Pilot trading regime.”
For many in our industry, the idea of conducting a Tick Size Pilot dates back to early 2012. While there was debate in its design and doubts on whether tick sizes play any role in liquidity, there was and remains a consensus that today’s one-size-fits-all market structure does not serve the needs of small to mid-sized companies and the investors who look to accumulate wealth and prosperity by investing in them at their early stages of existence. If the Commission decides to terminate the Pilot, which is highly likely, some individuals within our industry will cheer at that development. A natural reaction given the cost and herculean effort it took to implement it. Unfortunately, the problem that the Pilot sought to remedy will still exist and that is something none of us should cheer about.
Shift in Market Structure
Facilitating capital formation is a core function of our markets. In order for our markets to perform this role, efficiencies in regulation and competition need to exist among and within all the participants involved in the capital formation process: issuers, broker dealers, investment banks, exchanges and investors.
The dramatic shift from the manual nature of floor-based and over-the-counter trading in the late 1990’s caused by Reg NMS, decimalization and other events to today’s highly electronic and technologically efficient marketplace has been nothing short of impressive and radical. These disruptions brought efficiencies but the swiftness by which they occurred undeservedly laid waste to some of the functions performed and characteristics within our markets with regards to capital formation, one being market making.
Market makers, both electronic and traditional, as well as other enhanced liquidity providers play a vital role in the strength of secondary markets, which are critical for healthy primary markets. No company will go public if it does not have a reasonable expectation that its securities will be liquid in the secondary markets. For those, like STA, who supported a Tick Size Pilot, it began with the fundamental belief that market makers matter and their role had been marginalized unnecessarily. The costs and risks associated with operating a trading desk, be it for market making or facilitating institutional order flow, combined with low incentives create an inefficient barrier to entry that, over the long term, will not be good for anyone. As an industry we need to remedy this. While STA realized that tick sizes were only one contributory factor and that a modern way to incentivize market making was needed, we supported the Tick Size Pilot, albeit a simpler version.
In a letter to Senator Tim Johnson, then Chairman of the Committee on Banking, House and Urban Affairs dated March 20, 2012 we wrote:
“We believe both market makers and other liquidity providers dampen market volatility to the benefit of the marketplace and investor confidence. While we are not advocating a return to the past, we do believe in the benefits of enhanced liquidity and regulators need to find a modern way to incentivize its existence.”
Between the Tick Size Pilot and LULD our industry has come to realize that finding modernized versions to functions that served markets well is challenging. While STA is disappointed that the Tick Size Pilot did not achieve its intended goal, we are pleased with the respect paid to empirical data and the actions of our chief regulator.
Limit Up/Limit Down
The Tick Size Pilot was not our industry’s first attempt to reinstate a trading regime characteristic with a modernized version. Providing a means to deal with order imbalances is a core function in our markets. The Limit Up/Limit Down Plan was designed to reintroduce actions performed by specialists during moments of large order imbalances that were erased from the market in the aftermath of Reg NMS. The basic characteristics of the original LULD Plan were: disseminating pre-determined price bands; instituting trading pauses; and, providing an opportunity for price discovery during a paused state. With industry input, LULD was implemented and over time we learned that allowing for pauses in trading did not bring liquidity to the marketplace like it previously did. In fact it had the opposite effect. Since its original design, there have been several adaptions of LULD, most of which seek to limit the possibility of a paused state. The creation of an LULD operating committee allows for changes to the plan, which provides a means for the function to adapt to changes in market structure.
Access Fee Pilot
Between the Tick Size Pilot and LULD our industry has come to realize that finding modernized versions to functions that served markets well is challenging. While STA is disappointed that the Tick Size Pilot did not achieve its intended goal, we are pleased with the respect paid to empirical data and the actions of our chief regulator. The amount and quality of work by Commission Staff on the Tick Size Pilot needs to be recognized and appreciated. As our industry now debates the proposed Access Fee Pilot, we remain confident that the Commission will be diligent in their approach and we look forward to engaging with them.