September 18, 2024/US SEC
Today, the Commission will consider updating rules for the $55 trillion equity markets. I am pleased to support these rules because they would enhance competition, efficiency, and fairness, benefitting investors and capital formation alike.
In 1975, Congress tasked the Securities and Exchange Commission with responsibility to facilitate the establishment of the national market system and enhance competition in the securities markets, including the equity markets. Based on these new authorities, starting in 1978 and through 2005, the Commission has taken a number of actions promoting efficiency and competition in the equity markets.[1]
A lot has changed—in technology and business models—since we last took a comprehensive review of the national market system rules (Regulation NMS) in 2005.[2]
First, transaction volume in listed equities has doubled in the last five years and tripled in the last 17 years.[3] Second, the markets have moved to overwhelmingly trade electronically. Third, stocks representing approximately 74 percent of share volume are currently being quoted at less than 1.5 pennies. This compares to 2005 when 54 percent of stocks traded at less than 1.5 pennies.[4] Fourth, a large and growing portion of the market is being transacted off-exchange in what many call the dark markets. As of 2023, approximately 45 percent of share volume was executed in the dark markets,[5] up from 25 percent in 2009.[6] Lastly, there has been a significant increase in everyday investor participation in the markets. Per Federal Reserve statistics, about 58 percent of American households own stocks.[7]
Thus, I think it’s incumbent upon us to update our national market system rules. I believe the updates we’re considering today will help drive greater efficiency, competition, and fairness in our equity markets.
The updated rules would relax the one-penny minimum quotation increment first adopted in 2005. For many stocks, under the updated rule, the new minimum would be half a penny. Reducing what’s known as the “tick size” will benefit investors and market participants by allowing stocks to be priced more efficiently and competitively. This will lower costs for investors as well as improve liquidity, competition, and price efficiency in the markets.
When I started on Wall Street, markets were quoted in fractions of dollars as they had been all the way back to the 18th century. By the 1990s, though stock exchanges had shifted their rules to allow quotes in sixteenths of a dollar, investors were clamoring for lower quote increments. Such wide spreads may have benefited brokers and dealers, but investors benefit when quoted spreads are tighter.
Thus, in 2000, the SEC required the exchanges[8] to move to decimalization.[9] Market participants would be allowed to decide a minimum quote as long as it was in decimals. In doing so, the Commission stated that it “believes that decimal pricing could benefit investors by enhancing investor comprehension, facilitating globalization of our markets, and potentially reducing transactions costs, depending on the minimum price variant used.”
Later, in proposing Regulation NMS in 2004, the SEC observed that “the move to decimals (and specifically the move to a penny MPV [minimum price variation] for equity securities) also has reduced spreads, thus resulting in reduced trading costs for investors entering orders—particularly smaller orders—that are executed at or within the quotations.”[10]
The Commission also observed that while the benefits justified decimal pricing, there were potential costs when some market participants use de minimis quotes, stepping ahead of existing limit orders. Resting limit orders provide what economists call liquidity to the markets. To address this concern, when the Commission adopted Regulation NMS, it included the so-called “sub-penny rule” setting a minimum quotation increment of one penny.
A lot has changed since 2005.
First, I think it’s time to relax that limit on the market. The one-penny minimum has become outdated and too wide for many stocks in today’s markets. As I mentioned, in 2023 approximately 74 percent of share volume is being quoted at less than 1.5 pennies. While the Commission sought public comment on possibly reducing the tick size even further, I think it’s appropriate to take this incremental step in allowing trading centers to quote down to half a penny.
Second, in light of relaxing the minimum for quoting increments, it also is appropriate to lower the maximum fee that can be charged to access the best bid or best offer on an exchange. As part of Regulation NMS in 2005, the Commission set a cap of three-tenths of a penny on the fees that exchanges could charge for access. As the Commission said in 2005, for quotations to be fair and useful, “there must be some limit on the extent to which the true price for those who access quotations can vary from the displayed price.”[11]
Over the years, the Commission has received many requests to lower the cap to both address market distortions and reflect changes in the market since 2005.[12] As further discussed in today’s release, market participants have raised at least five concerns with the current level of the access fee cap. It: 1) undermines price transparency 2) introduces unnecessary complexity 3) adds to market fragmentation 4) raises potential conflicts of interest between brokers and their customers, and 5) benefits sophisticated market participants at the expense of other market participants.
Lowering the access fee cap from three-tenths to one-tenth of a penny, together with the changes to the minimum quoting increment, will lower costs for investors.
Third, the updated rule would ensure that traders can determine, at the time of executing a trade, any rebates of the access fee that may be paid to them on that trade. This transparency on rebates along with lowering of the access fee caps would promote efficiency, competition, and fairness in our markets.
Fourth, the final rules would implement an updated definition of a round lot. The current definition for round lots, 100 shares, is more than 120 years old. It no longer reflects today’s markets, particularly given the high prices at which many stocks trade. This matters because, under the Order Protection Rule adopted in 2005, only orders in round lots are provided price protection across the markets. Further, the updated definition of round lots would bring more quotes into the National Best Bid and Offer (NBBO), potentially leading investors to benefit from better pricing.
Accordingly, the final rules would implement a more flexible definition for round lots. Under this definition, a round lot’s size will be tiered (to 100, 40, 10, or 1 share), depending on the price of the share.
Finally, today’s updated rules will provide investors greater transparency on quotes for orders smaller than a round lot (so-called “odd lots”). Odd-lots comprise a growing percentage of market transactions, particularly for everyday investors.
The reforms we’re considering today will help promote greater transparency, competition, fairness, and efficiency in our $55 trillion equity markets. That goes to the heart of the SEC’s mission. The reforms are pro-investors. They are pro-capital formation.
I’d like to thank members of the SEC staff for their work on these final rules, including:
- Haoxiang Zhu, Andrea Orr, David Saltiel, David Shillman, Kelly Riley, Dan Gray, Alba Baze, Johnna Dumler, Steve Kuan, Marc McKayle, Leigh Roth, Yue Ding, William Miller, David Bloom, Sharon Park, Arun Manoharan, Dan Mathisson, Christopher Ray, Leah Drennan, and Sudha Bhat in the Division of Trading and Markets;
- Jessica Wachter, Oliver Richard, Jill Henderson, Lauren Moore, Paul Barton, Peter Dixon, Robert Girouard, Andrew Glickman, Ariel Lohr, Rebecca Orban, Joseph Otchin, Julia Reynolds, John Ritter, Kevin Roshak, Charles Woodworth, Yashar Barardehi, Qiyu Liu, Patti Vegella, Michael Davis, and Donald Edmond in the Division of Economic Risk and Analysis;
- Megan Barbero, Meridith Mitchell, Robert Teply, Janice Mitnick, Cynthia Ginsberg, and Ronesha Butler Office in the of the General Counsel;
- Michael Hershaft in the Division of Examinations; and
- Mandy Sturmfelz in the Division of Enforcement.
