SEC Proposes Rules Related to Minimum Pricing Increments, Access Fee Caps, and Transparency of Better Priced Orders

Key Takeaways

If adopted, the changes to minimum tick sizes would significantly affect all market participants, who would have increased opportunities to trade in more granular increments for a majority of NMS stocks rather than the $0.01 minimum tick most prevalent today. This would likely necessitate systems changes for a large number of market participants, including broker-dealers and exchanges, to allow for the submission, ranking, and display of orders at more granular pricing increments. Moreover, these minimum tick sizes will vary by stock and may change for each stock on a quarterly basis, which would require broker-dealer systems be able to accommodate such changes.

The changes to minimum tick sizes may also affect the competitive landscape between exchanges and OTC execution venues, such as OTC market makers. Under existing Rule 612, quotes and orders cannot be displayed, ranked, or accepted in subpenny increments, but the rule does not prohibit executions in subpenny increments. According to the SEC, OTC market makers are today able to trade more readily in subpenny increments than is possible on exchanges and ATSs, notwithstanding that certain exchange-operated retail liquidity programs do permit the display of subpenny retail orders pursuant to SEC exemptive relief. As a result, OTC market makers provide subpenny price improvement when executing orders, while exchanges and ATSs generally cannot. The SEC believes the proposed minimum pricing increment changes could allow exchanges to better compete with OTC market makers in providing subpenny executions.

The proposed changes to access fee caps could also affect the incentives for quoting on different exchanges. Today, many exchanges use a “maker-taker” pricing model, in which the exchange pays a rebate to a “maker” of liquidity and charges a fee to a “taker” of liquidity. The amount of such rebates and fees is typically limited by the access fee caps, which would be reduced if the Proposal is adopted.

Finally, with respect to the proposed new best odd-lot order (discussed in more detail below), market participants may find it confusing to understand when they are viewing the best odd-lot order and at which destination the best odd lot order resides. This may be particularly true when multiple venues display the best odd-lot order.

Background

Regulation NMS Rules 610 and 612 were adopted in 2005 to establish, among other things, access fee caps and minimum tick sizes. The SEC established a minimum tick size of $0.01 for NMS stocks priced at or above $1 to deter market participants from stepping ahead of displayed trading interest by an economically insignificant amount.⁸ The SEC established a cap on access fees of $0.003 per share for NMS stocks priced at or above $1 to prevent an exchange from charging an excessive fee for accessing a protected quotation on that exchange.⁹

The SEC believes that evolutions in data processing and communications technology as well as business practices since the adoption of Rules 610 and 612 warrant revisiting the current tick size and access fee levels to allow market participants to better determine the prices at which they would bid or offer. According the SEC, a majority of NMS stocks today are “tick constrained,” meaning that the pricing of such stocks is being artificially constrained by the current tick size.¹⁰ The SEC believes that access fees must also be reduced in conjunction with reducing tick sizes to help ensure that the access fee caps do not become too large in relation to tick sizes.

In December 2020, the SEC adopted the MDI Rules, which included (i) changes to round lots depending on the price of the security (rather than today’s uniform 100 share round lots) and (ii) adding to consolidated market data all odd-lot quotations priced greater than or equal to the national best bid (NBB) and less than or equal to the national best offer (NBO), aggregated at each price level at each exchange, in addition to odd-lot transaction data. The MDI Rules are in the process of being implemented, but the SEC estimates that it may be at least two years until the changes to round lots and inclusion of odd-lot order information are implemented.

Summary of the Proposed Changes

Minimum Tick Sizes and Access Fees

Under the Proposal, Rule 612 of Regulation NMS would be amended to introduce a variable minimum pricing increment structure for quotes and orders in NMS stocks priced at, or greater than, $1 per share based on the stocks time-weighted average quoted spread over a designated evaluation period as set forth below. The chart below also sets forth the applicable access fee for protected quotes under the proposed amendments to Rule 612:

Under the Proposal, the time-weighted average quoted spread for all NMS stocks would be evaluated by the primary listing exchange over an evaluation period to determine the appropriate minimum tick size. The evaluation period would be the last month of a calendar quarter (e.g., March during Q1, June during Q2 etc.). Once a stock’s tick size is determined, the stock would retain that tick size for the following quarter until next evaluated. The Proposal also sets forth a gradual implementation schedule for the transition to variable minimum tick sizes.

The SEC proposes two exceptions to the minimum tick sizes for orders that (i) execute at, but are not explicitly priced at, the midpoint of the NBB and NBO or best protected bid and the best protected offer and (ii) execute at a price that was not based directly or indirectly on the quoted price of an NMS stock at the time of execution and for which the material terms were not reasonably determinable at the time the commitment to execute the order was made (e.g., a volume-weighted average price order).

Access Fee Caps

In light of the proposed changes to tick sizes, the SEC also proposes to recalibrate access fee caps that limit what a trading center may charge for the execution of orders against a protected quotation — as set forth in the chart above. Absent such a recalibration, access fees would make up a larger proportion of the per share quotation price than they do today because of the proposed decreases in tick sizes, which the SEC believes could lead to unintended market distortions and undermine price transparency.

In addition, the SEC proposes to prohibit a national securities exchange from imposing, or permitting to be imposed, any fee or fees, or providing, or permitting to be provided, any rebate or other remuneration (e.g., discounted fees, other credits, or forms of linked pricing) for the execution of an order in an NMS stock unless such fee, rebate, or other remuneration can be determined at the time of execution. Under the Proposal, any national securities exchange that imposes a fee or provides a rebate that is based on a certain volume threshold (e.g., volume-based discounts), or establishes tier requirements or tiered rates based on minimum volume thresholds, would be required to set such volume thresholds or tiers using volume achieved during a stated period prior to the assessment of the fee or rebate. The SEC believes this will allow market participants to better determine the fee or rebate level applicable to an order at the time of execution.¹³ The practical challenges and expense that would go into complying with the requirements, however, may also be seen as an SEC attack on current payment for order flow practices.

Order Price Transparency — Round Lots and Odd Lot Order Information

Because the MDI Rules are still in the process of being implemented and the round lot tiers and odd-lot order information may not be implemented for over two years, as noted, the SEC proposes to accelerate adoption of the round lot provisions and odd-lot order information.

The Proposal would also amend the definition of odd-lot information under current Rule 600(b)(59) to include a new data element that would identify the “best odd-lot orders” to buy and sell. Specifically, the best odd-lot order to buy would mean the highest-priced odd-lot order to buy that is priced higher than the NBB, and the best odd-lot order to sell would mean the lowest-priced odd-lot order to sell that is priced lower than the NBO. If two or more national securities exchanges or associations provide odd-lot orders at the same price, the disseminator of consolidated market data (i.e., a securities information processor) would be required to determine the best odd-lot order by ranking all such identical odd-lot buy orders or odd-lot sell orders (as the case may be), first by size and then by time. We note that the Proposal does not affect the requirement that a protected quotation must be a round lot.

The proposed compliance date for the acceleration of round lots and odd-lot order information (including the best odd-lot orders) would be 90 days after adoption, based on the date of publication in the Federal Register.