Is sub-penny pricing the answer for exchanges?

The time apparently is right for the NYSE Euronext, Nasdaq OMX, BATS and others to get the whole issue of sub-penny pricing into the realm of the public. There's no doubt that it would help in certain areas. Big liquid stocks that have fallen to below $5 at some point, like Citigroup, Bank of America, Freddie Mac and Fannie Mae, are a prime example. Trading volume in these stocks at the main exchanges dipped along with stock prices as more institutions opted for dark pools and other alternative venues, where sub-penny increments are already a reality.

It's smart for the top exchanges to want to recapture this order flow. But it has to make sense in the larger scheme. It seems like the exchanges think the benefits can be generalized. Clearly, dark pools, especially of the internalized variety like Sigma X (owned by Goldman Sachs), are having a dramatic effect on the main exchanges. You have to wonder whether we'll see calls for wider spreads on higher-priced stocks, which would be a win for all. Perhaps we'll see price bands with specific increments attached. All this is pretty shocking for people who remember the decimalization move like it was yesterday. The technology has certainly progressed. 

Still, most people interpret the sub-penny gambit as a move against dark pools, which raises the question: How will dark pools react? You can bet the likes of Credit Suisse and Goldman Sachs, which run massive internalized pools, will not take it lying down. In general, dark pools could theoretically take increments even lower to preserve their advantages. It will be interesting to read their public comments.

One interested party has to be the ranks of high-frequency traders. They already exist in a world of razor-thin spreads. Their whole raison d'être is to make money via volume. If you were to take spreads down to a half penny or even a tenth of a penny, as some exchanges favor, you could really complicate their ability to make money, especially in times of reduced volatility. 

Broker dealers in general will feel the squeeze, just as they did when decimalization became a reality. Certainly, it will add fire to an already intense technology arms race, one that favors the big firms. All in all, the movement remains incipient. We'll just have to wait and see how things trend. - Jim