The Securities and Exchange Commission (SEC) is soliciting ideas from the public for improvements to the secondary market structure for exchange-listed equity securities that trade in low volume, or thinly traded securities.
The issue is fundamentally rooted in the equity market’s static structure, which follows a “one-size-fits-all” philosophy and consequentially materializes a relatively unfavorable situation for securities traded in low volumes.
“Although the Commission believes that the current equity market structure generally works well for securities that trade in higher volume, the Commission has concerns that the current ‘one-size-fits-all’ equity market structure…may not be optimal for thinly traded securities.”
Issues regarding the difficulties typically paired with thinly traded securities, such as “wider spreads and less displayed size relative to securities that trade in greater volume, often resulting in higher transaction costs for investors,” pose a concern for potential investors who might worry about liquidity issues. This might potentially lead to hesitancy to invest in the issuer’s securities, subsequently hampering the issuer’s financing efforts.
According to an October 2017 Capital Markets Report published by the US Department of the Treasury, “the current ‘one-size-fits-all’ structure of the equity markets is not operating effectively for smaller companies that experience lower levels of liquidity today…liquidity requires a large pool of investors who want to buy and sell securities, as well as venues that allow them to interact.”
As a result of the report, the Treasury requested the SEC look into the issue to consider whether to bring about regulatory changes “aimed at promoting improved liquidity for these companies by tailoring regulation more appropriately to improve the market for less liquid stocks.”
One culprit is equity market regulation that encourages competition among multiple trading venues, intended to benefit trade execution pricing and market innovation. While this works well for heavily trade stocks because the trading volume can support many trading venues, it’s not so great for thinly traded stocks, because relatively small volumes of securities are spread out among different areas.
The Treasury noted that “this fragmented volume makes finding the contra side to a trade more difficult and can disincentivize market makers to quote in large size on any given trading volume as they limit their quoting size to better manage their risk.”
SEC Chairman Jay Clayton said, “As we have heard from issuers, exchanges, and other market participants, a one-size-fits-all approach to market structure does not work for many of our public issuers, particularly small and medium sized companies. We want to know if more can be done to improve secondary market quality for thinly traded securities, and we look forward to seeing proposals geared to enhance trading and liquidity for this segment of the market while maintaining or improving market integrity.”