The SEC voted unanimously to adopt changes to Regulation NMS (Reg. NMS) that address minimum pricing increments for securities, the access fees that securities exchanges charge, and increased transparency order prices. The Reg. NMS Amendments:
- Establish a second minimum pricing increment, also known as tick size, of $0.005 for certain stocks listed on a national securities exchange (NMS Stock) - Tick Size Provisions,
- Reduce the maximum fees that trading centers (e.g., securities exchanges) can charge for execution against protected quotations (access fee caps) and require that the amounts of all fees and rebates be determinable at the time of execution - Access Fee Provisions, and
- Accelerate the implementation of the round lot and odd lot information definitions adopted in 2020 and add information about the best odd lot order to the definition of odd lot information – Odd Lot Provisions.
The Reg. NMS Amendments are the second market structure rule change that the SEC has adopted since proposing a significant overhaul of the U.S. equities markets in December 2022. In March 2024, the SEC adopted changes to Rule 605 under Regulation NMS to enhance disclosure of order execution information. The SEC has yet to act on the arguably more controversial aspects of its market structure overhaul – (1) a best execution standard for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers and (2) the order competition rule proposal that would require certain retail customer investor orders be exposed to auctions.
Tick Size Provisions – Rule 612 Minimum Pricing Increments
Background and Proposal
As explained by the SEC, investors used various order types to buy and sell securities, including limit orders, which specify the price at which an investor is willing to buy or sell a security. Because limit orders serve a critical market function, the SEC adopted Rule 612 under Regulation NMS, requiring that the prices of quotations and orders be reflected in a specified minimum pricing increment – i.e., the “tick size.” Under Rule 612, the minimum pricing increment for quotations and orders of NMS stocks priced at or greater than $1.00 per share is $0.01 (i.e., penny increment). The penny increment requirements help ensure that other market participants could not step ahead of a limit order with a sub-penny order in a way that would disincentive market participation. In contrast, larger pricing increments would increase spreads and potentially cause investors to pay more for stock than they otherwise would if spreads are tighter. With the rise of electronic trading and overall changes in the market, the SEC in 2022 proposed further tightening spreads by permitting sub-penny pricing increments for certain tiers of NMS stocks.
When the SEC originally proposed the Reg. NMS Amendments, it contemplated a complicated sub-penny pricing increment framework that would introduce three minimum pricing increments that were less than $0.01 (i.e., $0.005, $0.002, $0.001) for quotes and orders priced $1.00 or more using a complicated weighted average. In response to comments, the SEC adopted a less burdensome framework.
Amendments
As adopted, the amendments to Rule 612 introduce only one minimum pricing increment that is less than $0.01 (i.e., $0.005) for quotes and orders priced $1.00 or more for NMS stocks that have a time-weighted average quoted spread (TWAQS) of $0.015 or less. There is no minimum pricing increment for trades.
For bid or offer, order, or indication of interest (quotes and orders) that is priced equal to or greater than $1.00 per share, amended Rule 612(b)(2) prohibits a trading venue from displaying, ranking, or accepting quotes or orders in an increment smaller than:
- $0.01, if the TWAQS for the NMS stock during the Evaluation Period (as defined below) was greater than $0.015; or
- $0.005, if the TWAQS for the NMS stock during the Evaluation Period was equal to or less than $0.015.
Where an order or quote is priced at less than $1.00 per share, amended Rule 612(b)(3) prohibits a trading venue from displaying, ranking, or accepting quotes and orders in an increment smaller than $0.0001.
The minimum pricing increments for quotes and orders will be assigned on a semiannual basis using three-months of trading data to calculate each NMS stock’s TWAQS. A minimum pricing increment of either $0.01 or $0.005 will be assigned to each NMS stock for quotes and orders that are priced equal to or greater than $1.00 per share twice a year and will be operative for a six-month period.
Key Definitions
- Evaluation Period: (i) the three months from January through March of a calendar year and (ii) the three months from July through September of a calendar year during which the TWAQS of an NMS stock shall be measured by the primary listing exchange to determine the minimum pricing increment for each NMS stock.
- TWAQS: the average dollar value difference between the national best bid (NBB) and the national best offer (NBO) during regular trading hours where each instance of a unique NBB and a unique NBO is weighted by the length of time that the quote prevailed as the NBB or NBO. For new NMS stock (i.e., IPOs), the minimum pricing interval will be one penny, and then will be re-calculated during the succeeding Evaluation Period interval.
The final amendments also require the primary listing exchange for each NMS stock to calculate and provide an indicator of the applicable minimum pricing increment required under Rule 612 to competing consolidators, self-aggregators, and the exclusive securities information processors.
Access Fee Provisions – Rule 610 OF Regulation NMS
Background and Proposal
As explained by the SEC, trading venues can choose to charge an access fee, or pay a rebate, to the participants accessing the venue. Market participants with orders resting at the trading venue – liquidity providers – often receive rebates. Market participants who submit incoming orders to execute against orders resting at the trading venue – liquidity takers – are often charged access fees. Within this structure, known as the maker-taker model, the access fees charged are often what is used to fund rebates to liquidity providers.
Rule 610(c) of Regulation NMS set the access fee cap for protected quotations priced at $1.00 or more at 30 cents per 100 shares (“30 mils” per share). That rule also applies to any other quotations of a trading center that is the best bid or offer. Rule 610 was adopted at the same time as Rule 611, the Order Protection Rule, which established intermarket protection against trade-throughs (where a trading center executes an order at a price that is inferior to the price of a protected quotation that is displayed by another trading center). According to the SEC, Rule 610(c) intends to keep trading centers quotations from raising their fees to take advantage of the trade-through protections. The SEC identified several issues with the current access fee caps, which prompted its decisions under the amendments to address price distortions, conflicts of interest, and price transparency issues.
The SEC initially proposed to amend Rule 610 by:
- Reducing Rule 610(c)’s 30 mil cap for executions against protected quotations priced $1.00 to: a $0.001 (or 10 mils) access fee cap for NMS stocks that would have been assigned a minimum pricing increment larger than $0.001; and a $0.0005 (or 5 mils) access fee cap for NMS stocks that would have been assigned a $0.001 minimum pricing increment;
- For protected quotations in NMS stocks priced under $1.00 per share, the SEC proposed reducing the 0.3% fee cap to 0.05% of the quotation price; and
- Requiring that all exchange fees charged, and rebates paid, for the execution of an order in an NMS stock be determinable at the time of execution as opposed to the end of the month.
Final Amendments
In response to comments, the SEC is adopting only the proposed 10 mil per share access fee cap for all protected quotations priced $1.00 or more. For protected quotations priced less than $1.00, the SEC adopted an access fee cap of 0.1% of the quotation price per share. The SEC adopted the proposed requirement that all exchange fees charged, and rebates paid, for the execution of an order in an NMS stock be determinable at the time of execution.
Odd Lot Provisions
In 2020, the SEC amended Regulation NMS to modernize the NMS information provided to market participants and to better achieve the goals of assuring “the availability to brokers, dealers, and investors of information with respect to quotations for and transactions in securities that is prompt, accurate, reliable, and fair” (MDI Rules). The SEC proposed accelerating the adoption of certain provisions in the MDI Rules dealing with round lot and odd lot information.
As explained by the SEC, until the MDI Rules are fully implemented, the NMS information that is disseminated to market participants will include information about “round lots” that are largely defined by exchange rules to mean 100 shares. Information about odd lots is generally only available by purchasing additional data feeds. In order to alleviate these issues, the MDI Rules expand the types of NMS information that will be made available to market participants. It does this by, among other things, amending Regulation NMS to include a definition of “round lot” that assigns each NMS stock to a round lot size based on the stock’s average closing price.
The purpose is to increase transparency about smaller-sized orders in higher-priced stocks by assigning NMS stocks priced over $250 to round lot sizes that are less than the predominant 100 shares. However, there have been delays in implementing the MDI Rules, which prompted the SEC to propose an accelerated implementation of the round lot and odd lot information definitions, to allow investors to benefit sooner from greater transparency and accessibility of better-priced orders and improved execution quality. In addition, the SEC adopted amendments to the definition of odd lot information under Rule 600(b) that will add a new data element that will identify the best odd lot orders to buy and sell across all national securities exchanges and national securities association. The Reg. NMS Amendments accelerate the adoption of these definitions.
The Impact
The Reg. NMS amendments are the second least controversial of the market structure proposals that the SEC published in December 2022. Nonetheless, the SEC appears to have been amenable to addressing commenter concerns such that the tick size and the access fee provisions have been significantly curtailed. This may reflect a recognition on the part of the SEC that its proposals are subject to pushback where they reach too far and that market participants are now postured in a world where courts are not as deferential to the SEC’s actions. Indeed, the fact that the final vote was unanimous may reflect a willingness on the part of the SEC chair to seek palatable comprises.
That’s not to say that the final rules are without concern. While the SEC noted that the reduction in access fee caps should not hinder an exchange’s operations, the suggestion that exchanges will potentially see an increase in volume, as reflected during the open meeting, may be premature. In this respect, because exchanges are meant to have less cash available for rebates, coupled with the requirements that rebates be calculable at execution, it’s unclear whether the final rules will adversely impact the economics of payment-for-order flow practices. These practices have helped fuel an era of commission-free trades and the impact of the final rules to those practices is yet to be determined. However, a declining interest rate environment, coupled with increased scrutiny by regulators of revenues derived from sweep and bank deposit programs, may impact broker-dealer revenue sources.
