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Regulation NMS Amendments: Summary & Impact

September 19, 2024

September 18, 2024, SEC commissioners announced groundbreaking changes in U.S. equity market structure. The rules will have a significant impact on investor costs as well as the competitive landscape for exchanges, dark pools, brokers, and internalizers.

The minimum tick size for tick-constrained stocks–those with an average spread of less than 1.5 cents–will be reduced to 0.5 cents.

These stocks are characterized by a combination of lower prices, higher volumes, and lower volatility. The affected stocks have a median daily volume of 1.1 million shares and an average price of $21. Stocks not impacted by this rule have a median daily volume of 50,000 shares and an average price of $144.

For affected stocks, the "natural" spread in the absence of a tick size would be much more narrow. A wider tick relative to the natural spread makes it more attractive to earn the spread and more expensive to cross it, which results in long queues on exchanges. Stocks impacted by this rule have an average queue size of 8,000 shares compared to 500 shares in the other group. Notably, about 50 stocks in the affected group have an average depth of more than 50,000 shares.

Impact: While only 15% of stocks (1,633 stocks) will have a reduced tick size, these stocks represent 67% of share volume in the U.S. equity market (see table in the appendix). Currently, market forces are circumventing the artificially wide tick size in several ways. Exchanges have created inverted pricing models that are popular for this group of stocks. Inverted pricing models make it cheaper to cross the spread since they offer rebates for taking liquidity, effectively reducing the minimum spread traders are required to pay. With reduced tick sizes, inverted exchanges are likely to become less relevant. Internalizers (SDPs and wholesalers) benefit by intercepting order flow and, effectively, jumping queues. A smaller tick size should reduce the difference in adverse selection faced by internalizers and those providing liquidity on exchanges.

The maximum exchange access fee will be reduced to 10 mills from the current cap of 30 mills.

While regulators should not be in the business of price setting, the SEC is required to set the maximum access fee as per the Order Protection Rule.

Impact: The price difference associated with providing liquidity from one exchange to another can be as large as 60 mills under the current access fee cap. This difference will shrink to 20 mills under the new rule. Since agency brokers absorb the venue fees for most asset managers, this will help reduce conflicts of interest. It should also benefit agency brokers because the range of costs from one client to another (depending on whether they are taking or providing liquidity) will become more predictable.

Exchange fees will now be passed in real time with each transaction.

Impact: Currently, exchanges offer extremely complex pricing schedules, creating price discrimination by segmenting clients into hundreds of categories based on various criteria, and charging different rates. In addition, fees for transactions are generally determined by market participants’ activity within the current month, making it impossible for any participant to predict their exchange fees with certainty. While the issue of complexity may not be resolved by the requirement that exchange fees be determined in real-time, it will be required that they be determined on participant volume and activity from an earlier (concluded) period of time, increasing the transparency of the complex fee structure at a minimum. Many quantitative buy-side firms are moving toward a cost-plus model of execution, and this change will greatly simplify their operations. One might hope that exchanges will simplify their pricing schedules to provide this transparency in real time, but this may not be the case.

The round lot size reduction for high-priced securities will be expedited.

This rule was approved under the previous administration, but this specific aspect of the Market Infrastructure Rule will now be accelerated. Under this rule, the lot size for securities priced between $250 and $1,000 will be reduced to 40 shares instead of 100. Securities between $1,000 and $10,000 will have a 10-share lot size, and those above $10,000 will have a 1-share lot size.

Impact: While only 210 securities will be impacted by this rule, these represent approximately 25% of the overall market’s notional volume. The rule is designed to create more transparency for odd lots (which may now become round lots under the new definition). While odd lot trades are published on the consolidated tape, their quotes are not. This means that proprietary exchange feeds provide more information than SIP feeds. For example, 100 shares of a $50 stock posted at the NBBO will be visible, but 10 shares of a $500 stock will not be—even though both represent the same economic value. Moreover, these orders are currently not protected and can be traded through.

This issue is currently mitigated somewhat because exchanges aggregate all odd lots at a given price level (or below), and when the aggregated size reaches a round lot, it is published via SIP feed and protected. For example, if Nasdaq had two buy orders posted at $50.10 for 40 shares and one order posted at $50.11 for 20 shares, a seller could sell 100 shares at $50.10 or better. The $50.10 bid would be shown as the best bid for Nasdaq on the SIP feed, with 100 shares posted. Reducing the lot size will mitigate the issue further, allowing lots with sufficient economic value for investors to be displayed at NBBO and treated the same as lower-priced securities.

Summary: The SEC rules announced on September 18, 2024 were approved unanimously, and we wholeheartedly support these changes. These rules will reduce liquidity fragmentation (due to reduced tick sizes), increase transparency, and reduce market complexity.

For more information about the RegNMS amendments, see:

Appendix: Table of Stock Characteristics Based on Current Spreads

This material reflects the views and opinions of BestEx Research Group LLC. It does not constitute legal, tax, investment, financial, or other professional advice. Nothing contained herein constitutes a solicitation, recommendation, endorsement, or offer to buy or sell securities, futures, or other financial instruments or to engage in financial strategies which may include algorithms. This material may not be a comprehensive or complete statement of the matters discussed herein. Nothing in this paper is a guarantee or assurance that any particular algorithmic solution fits you, or that you will benefit from it. You should consider whether our research is suitable for your particular circumstances and needs and, if appropriate, seek professional advice.