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May 1, 2013

At Odds Over Increments

Industry Clashes on Bigger Ticks for Small Stocks

By Peter Chapman

Also in this article

Are higher trading costs justified if they produce more support for small- and mid-cap stocks?

That question is at the heart of a debate among trading practitioners, regulators and academics as the Securities and Exchange Commission mulls the introduction of a pilot that could quintuple the size of the minimum trading increment.

Any such move would widen spreads, and thereby increase investors' costs, but could also potentially increase liquidity in small-capitalization stocks. In theory, market makers would step up their quoting in the small names.

To a certain extent, which side of the debate a trader falls depends on his trading style. For price takers, if the minimum trading increment increases, then crossing the spread-hitting the bid or lifting the offer-becomes more expensive. But for price makers-those asset managers who prefer to post limit orders on exchanges-a bigger tick would reduce their risk.

Kevin Cronin,Invesco

Kevin Cronin, global head of equity trading at Invesco, is in the latter camp. "Why don't we post bids and offers in small-cap stocks?" asked Cronin, speaking at an SEC roundtable in February. "Because the price increment is a penny. It involves a minimal amount of risk to jump in front of an order. If there are more incentives to post bids and offers for institutions, then it will change the attraction for that security. Five cents is a much more meaningful increment."

Brian Conroy, president of Fidelity Capital Markets, part of the big mutual fund company's brokerage arm, was also part of the roundtable. He is worried about an increase in trading costs. "We are concerned that if there are changes in decimalization, or an increase in tick sizes, that our transaction costs would go up with no discernible benefit to the end investor," Conroy told the SEC. "The traders on our investment management side would say they don't want partners when buying and selling positions. We'd rather have it remain an agency market," he said.

Conroy became president of Fidelity's agency brokerage in 2011. Before that, he spent six years as head of global equity trading at Fidelity Investments.

A Rollback

Under "decimalization," a set of rule changes that went into effect in 2000 and 2001, the minimum trading increment was reduced from 6.25 cents to a penny. The 80 percent cut eviscerated spreads, which caused hundreds of market makers to shut their doors. Investors benefited, however, as trading costs shrunk dramatically.

Any move to increase the minimum trading increment would, in effect, amount to a rollback of decimalization for those names. Under the Jumpstart Our Business Startups, or JOBS, Act, the SEC is required to examine the impact of decimalization and consider an increase in tick sizes.