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Tick Size Fever - 19th June 2009

Fidessa : Fidessa - 1st January 1970

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There has been much debate this week around the move to smaller tick sizes as Chi-X, Turquoise and BATS all announced that they will unilaterally reduce tick sizes in the stocks most commonly traded on their platforms. This is in the belief that smaller tick sizes lead to tighter spreads and so will attract even more volume on to these MTFs. This move was taken ahead of the planned initiative by the Federation of European Exchanges (FESE) to try and harmonise tick sizes and so may well result in an unsightly scramble as every venue tries to outdo its competitors with smaller and smaller tick sizes.

This raises a number of issues from a technology perspective. Firstly, most smart routers are configured with a minimum execution threshold and so they will ignore a better price unless there is enough volume there as well. These thresholds are set so as to reflect the extra cost and complexity of clearing and settling orders that are split over multiple venues. Smaller tick sizes will also focus best execution decisions on total cost of execution (rather than just price) and so will raise the stakes in terms of platform latency as high velocity traders tune their algos to exploit these new opportunities.

As tick sizes become more and more granular then this will lead to an increase in market data volumes, too. There's an interesting parallel here with the equity options market in the US which, for a few years, has been introducing a penny pilot scheme that aims to reduce the tick sizes in options contracts. Many vendors and exchanges have had to introduce techniques to mitigate the impact of the increased market data feed so as to remove unwanted "noise" by allowing traders to focus on just the contracts they are interested in. The difference is that, in the US, all of this has been co-ordinated in an orderly way by a centralised regulatory body (in this case, the OIC) through a phased approach. This has meant that the industry has had a chance to collectively adapt its systems in such a way so as to benefit the real end user with tighter spreads and lower costs of execution. In Europe, on the other hand, the reduction in tick sizes is happening in a far more haphazard manner, driven by short-term competitive factors.

At a time when the price the market is prepared to pay for market data is on a downward trajectory it seems that the cost of its provision is going up and this extra cost will have to be reflected somewhere in the trading food chain. If MiFID is about providing a better deal for the end customer then surely transparency should be a key component of this.

Finally, Burgundy had its official launch party in Stockholm this week. The event was very well attended and if they can get as much liquidity on their platform as was flowing at the party then the future looks good for Olof and his team. We will be including Burgundy in the stats, as well as more comprehensive Nordic coverage, by the end of July. Thanks to Olof and the rest of his staff for a great evening.