The SEC’s Approval of a New Pricing Scheme Benefits Investors, but Brokers May Suffer

The Security and Exchange Commission’s (SEC) new rule amendment on “tick-size” should help most investors and perhaps “tick-off” those who hold shares in brokerage stocks. The SEC’s introduction of the half-penny rule marks a significant shift in the U.S. stock market’s operational framework. While investors and high-frequency traders stand to gain from reduced costs and increased trading opportunities, broker-dealers face the challenge of adapting to a new revenue landscape.

This change could redefine how trading is conducted, pushing for innovation in the brokerage sector while ensuring the market remains competitive and fair for all participants.

Details of the SEC’s “Tick-Size” Amendment

The SEC approved a rule requiring thousands of stocks to be quoted in half-penny increments. As most investors know, public equities currently trade in full penny bids and offers. This new regulation is seen as a significant shift in how stocks will be traded and is expected to benefit investors by reducing transaction costs. The timeline for implementation is November 2025. At that point, this rule will initially apply to nearly 2,400 securities, including stocks and exchange-traded funds (ETFs).

The fractional increments between bid and ask prices are expected to result in more competitive markets, enhancing the efficiency of execution and trading.

Why this Change Matters to High-Frequency Traders?

High-frequency traders (HFTs) are likely to welcome this change. Their strategies depend on small, fast trades that take advantage of minute price fluctuations. The SEC has created a more favorable environment for these traders by allowing trades to be made in half-penny increments. Increased liquidity and narrower spreads mean HFTs can execute trades more efficiently, capturing smaller price differences across multiple trades. This rule could boost their profitability, as narrower spreads offer more opportunities to profit from rapid trading.

Impact on Retail Investors: Lower Costs and Better Access

Retail investors, who continue to grow in the stock market, can also expect to benefit. The narrower spreads between bid and ask prices will reduce the cost of entering and exiting trades. Over time, this could result in significant savings, particularly for those who trade often. Additionally, the SEC’s rule could level the playing field between institutional and retail traders, increasing market participation from everyday investors. The long-term implications could include higher market liquidity and increased stock market accessibility.

Broker-Dealers Face Profit Squeeze

While the new pricing rules are set to benefit many market participants, one group may see a downside: broker-dealers. Broker-dealers typically profit from the difference between the bid and ask prices, known as the spread. With the SEC compressing these spreads, broker-dealers may see a reduction in their profit margins. Brokerage firms, especially those relying on payment for order flow, could narrow their revenue streams.

Payment for order flow has been a critical part of many brokers’ income generation, particularly since the rise of commission-free trading. The new rule might force brokers to broaden alternative (non-trading) revenue sources.

Full adoption of the smaller tick trades is scheduled to begin more than a year after the amended rule approval. However, according to the TipRanks Comparison Results tool, two of three brokerage stocks underperformed the S&P 500 on the day of the announcement, which had declined by 0.29%. Interactive Brokers (IBKR) fell along with Charles Schwab (SCHW), while Robinhood (HOOD) outperformed the market by a wide margin.

A Boost to Market Transparency

One of the SEC’s key motivations for introducing this rule is to increase market transparency. The half-penny rule is part of a broader initiative by the SEC to create a more competitive and equitable marketplace. By narrowing spreads, the rule promotes fairer pricing for all investors, likely to increase trust in the stock market.

Additionally, the SEC aims to alter how exchanges negotiate rebates with brokers. This move could lead to more transparency in the fees brokers charge their customers, giving investors better insight into how much they pay to trade.

The Bigger Picture: Investor-Centric Regulation

This rule change is just one in a series of investor-focused reforms the SEC has pursued under Chair Gary Gensler. Other recent regulatory initiatives include overhauling how securities are traded in the dark pool and reshaping how exchanges handle rebates. These changes share a common goal: reducing trading costs and increasing market fairness.

The broader theme of these regulatory moves is to create a more efficient and competitive market where all participants, from retail investors to institutional traders, can benefit from improved transparency and lower costs.

Key Takeaways

The SEC’s introduction of the half-penny rule marks a significant shift in the U.S. stock market’s operational framework. While investors and high-frequency traders stand to gain from reduced costs and increased trading opportunities, broker-dealers face the challenge of adapting to a new revenue landscape. This change could redefine how trading is conducted, pushing for innovation in the brokerage sector while ensuring the market remains competitive and fair for all participants.