Outlook 2017: Jim Ross, Coda Markets
Jim Ross is managing director of institutional equities at alternative trading system operator Coda Markets
How has trading of small- and mid-cap stocks changed and will it continue to change in 2017?
Last year saw several broad market-structure initiatives across the regulatory, exchange, and ATS fronts, all of which attempted to address the challenges investors face sourcing and executing liquidity in small and mid-cap (SMID) issues. Improving liquidity provision, neutralizing latency arbitrage, increasing venue transparency and reducing information leakage were prominent and common themes throughout the year, but each solution only seemed to grapple with one of these themes.
Liquidity Provision: In October, at the request of the US Securities and Exchange Commission, the Financial Industry Regulatory Authority launched a Tick Size Pilot Program “to evaluate whether or not widening the tick size for securities of smaller capitalization companies would impact trading, liquidity, and market quality of those securities.” The regulator’s idea was that by allowing five-cent tick increments, for example, market makers would be more inclined to provide liquidity thus strengthening the SMID marketplace for investors.
However, the early evidence suggests that while liquidity has “deepened” a little around the quote, the Tick Pilot is having no impact on institutional trading volumes, according to KCG’s Head of Trading, Phil Mackintosh. In fact, some liquidity has even shifted to dark venues. Widening tick sizes also bring up another issue – increased costs – which may, in time, actually dilute liquidity in the Tick Pilot stocks. Translation: Mandating wider tick sizes for small cap stocks may actually do more harm to SMID stock liquidity than good. Stay tuned.
Latency Arbitrage: In June, after much debate, IEX commenced operations as an Exchange. IEX’s 350-microsecond “speed bump” has prompted other exchanges to consider developing their own delay offering. But the innovation has not yet translated into new volume capture for IEX, nor has it parlayed into any notable progress for SMID stocks. On the other hand, IEX continues to challenge the exchange status quo, which means no more business as usual. That could eventually bode well for SMID stocks.
Information Leakage: In the independent ATS arena, Luminex, the new big buy-side-only ATS, saw its first full year of operation, demonstrating that institutions saw value in limiting market participants. FINRA trade data, however, shows that although Luminex was adept at executing large block trades in mega- and large-cap stocks, it struggled with low-volume SMID stocks. This performance calls into question whether a segmented, buy-side-only model can resolve the liquidity challenge in SMID stocks.
Moving Forward: The small- and mid-cap liquidity problem has plagued investors and traders alike for decades, and no market structure initiative to date has yet to pull the proverbial sword from the stone. Increasing liquidity, leveling the playing field and reducing information leakage are vital goals, but solving one does not resolve the SMID liquidity dilemma.
In 2017, markets will have to adopt a more multi-dimensional approach to the SMID market that delivers price competition, liquidity discovery and informational control all in one dynamic market structure initiative. Now that will be something to write about in 2017!
MiFID II effectively increases the minimum block size for many instruments.
Single-dealer platforms offer a non-displayed alternative.
The hub simplifies access to systematic internalisers via an API.
Chuck Mackie of Maven Wave was in Chicago last week.
How has trading small caps not listed on big exchanges changed in 20 years?