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August 1, 2012

Exec Opposes Sub-Penny Pricing

By James Armstrong

There's nothing wrong with regulators experimenting with new pilot programs in order to improve the structure of the equity marketplace. But the one thing they should avoid at all costs is sub-penny pricing.

That's according to Kevin Cronin, global head of equity trading for Invesco. He said sub-penny pricing would be an absolute disaster for the industry. If traders could jump in front of an institutional bid or offer for a tenth of a cent, institutions would never want to post bids or offers, he said.

He was sympathetic to the idea of a trade-at rule-which would require broker-dealers to give meaningful price improvement in order to internalize trades. But he said it would cause more harm than good if it included sub-penny pricing.

Kevin Cronin

Stocks under a dollar already trade at sub-penny increments, and an argument could be made for sub-penny pricing for stocks under two or three dollars, but under no circumstances should that regime be applied across the board, Cronin said.

"The top 100 or 200 names trade well in a penny environment, but the vast majority of others don't, so why in the world would we go to sub-pennies?" Cronin said. "That would be among the worst developments that could happen in the U.S. equity markets."

Instead, he suggested a pilot program that would make tick sizes larger. Regulators could permit certain smaller stocks to trade at increments of more than a penny and see if that increases liquidity. Cronin said liquidity is currently a problem with a number of smaller stocks, and if larger tick sizes could increase liquidity in those names by drawing in more market makers, buyside firms like Invesco would definitely be more likely to hold them.

Cronin was supportive of the idea to impose fees on cancelled orders. Several exchanges have proposed such fees, but Cronin said those plans would likely penalize too few players to be effectual. He told Traders Magazine the bar could be gradually raised until it started having a positive impact on the market.

"It would be very dangerous for anybody to just pick a number and say that anything more than, for instance, 30-to-1, is a bad number for cancelations to trades," Cronin said. "Who is to say that wouldn't wipe out entirely a highly beneficial market-making strategy that actually did provide liquidity to the markets?"

Gradually increasing standards would be the safest approach to cancelation fees, he said, though there are other options. Thomas Joyce, chief executive officer of Knight Capital Group, has recommended minimum quote durations, which Cronin said could also work.

Another market-structure issue that troubles Cronin is the system of liquidity rebates that incentivizes brokers to make routing decisions based on rebates rather than on what is best for the client. While it's difficult to tell how bad the problem is-or even if there is a problem at all-a pilot program could shed light on the effects such rebates really have.

Cronin suggests prohibiting rebates for a certain set of securities so regulators can study the trading data and determine if further rulemaking is warranted.

"See if that changes behavior," he said. "We might have a hypothesis on what it would do, but let's see. Let's put the data together and see what the experience shows us."

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