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July 31, 2003

The Problems Of Decimal Pricing: The Minimum Tick Size Is Spreading Pain

By Nina Mehta

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  • The Problems Of Decimal Pricing: The Minimum Tick Size Is Spreading Pain
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The time has come for the regulators to overhaul a celebrated and controversial market structure reform, according to some institutional traders.

The introduction of decimalization is triggering widespread complaints from many pros. Sure, decimalization has brought some benefits to investors, benefits such as the reduction of explicit costs. But the minimum tick size of a penny has led to serious problems, say these pros.

Here is the traders' litany of decimalization complaints: With 100 price points when there had been only eight (or 16 for listed stocks prior to the markets going metric), liquidity has practically dried up. It's harder to see the depth of the market. It's harder to find big blocks of liquidity. More price points translate into more market impact. Penny jumping has become a lucrative sport for some. Market makers and specialists are also reportedly earning less. That further crimps liquidity in some market segments, traders say.

Security Traders Association President and CEO John Giesea maintains that decimalization has hurt transparency, hampered liquidity and increased the costs of trading for investors.

Active stocks appropriately trade in penny increments, he says. Without trumpeting nickel increments as the way forward - a reform that many of his members have been pushing - Giesea stresses that the value of liquidity providers is critical in the less actively-traded securities.

"Potentially increased minimum price variation might serve to bring some liquidity back to the marketplace in those stocks that don't trade 20 million shares a day," he said. But the issue is more than price, it's also simply finding liquidity, said one securities industry pro.

"The question isn't simply what's less available but also [what's] less visible," said Brandon Becker, a partner at law firm Wilmer Cutler & Pickering and a former director of the Securities and Exchange Commission's Division of Market Regulation. "There may be in aggregate the same amount of liquidity, but it's not as readily visible and therefore people have a harder time gauging at what point significant amounts of securities can be traded. That creates its own set of nightmares for them."

Just institute a minimum nickel price variation, some traders say. This, they say, would restore depth to the market. Marlene Walker Smith, a senior equity trader at Mellon Equity Associates in Pittsburgh, says decimalization has accomplished some good, but that nickel increments would have been preferable to pennies. "There's not much risk to shoot against you - it's a penny," she said.

Penny Jumping

Traders have responded to penny jumping and reduced liquidity by executing orders differently. "We're not putting out big volume anymore, we're not showing size on the floor of exchanges any longer," said Smith. "We tend to split orders up and work them in smaller pieces."