GREENWICH, Conn. - The vast majority of buy-side institutional equity traders think the move to decimal trading has done more harm than good, according to a survey conducted by Greenwich Associates.
The much-heralded switch to pricing stocks in pennies rather than fractional amounts was instituted on major domestic exchanges last year. And according to Greenwich, it has served individual retail traders but has done little to benefit institutional investors.
According to the survey, which was conducted online from Oct. 9-19, 70% of institutional investors said they have a negative view of the impact decimalization has had on the New York Stock Exchange and Nasdaq. Only 15% said they have a positive view of decimal trading.
Decimalization was adopted ostensibly to promote a more efficient market, "but institutional traders are not seeing lower transaction costs as a result," according to the Greenwich survey. "In fact, despite recognition that spreads have decreased because of decimalization, overall transaction costs are rising as traders struggle with a set of new market issues brought on in part by the shift to the new pricing system."
More agency trades?
Institutional investors' widespread dissatisfaction with decimal trading comes on the heels of increased market volatility in recent months, which could prompt a move to agency-based trades in the future, according to Greenwich consultant Jay Bennett. Agency trades are based on commissions rather than profiting from the bid/ask spreads currently used in large institutional trading.
Decimal trading has caused investors to break large blocks into several pieces involving multiple trades to get one transaction completed, resulting in a "propensity for errors" because of the different pricing for each trade, the study said.
According to Greenwich, 71% of traders disagreed with the statement "decimalization has improved the overall quality of (trade) execution."
"While traders report saving a few cents a share on the Nadsaq side, there's a widespread belief that transaction costs overall have increased," said Melissa DeVries, Greenwich community manager who coordinated the survey. "The loss of market transparency is raising a question in many traders' minds as to what's being lost on the back end."
"I think we weren't completely surprised at the negative feelings (toward decimal trading)," said Ms. DeVries. "We were surprised at the extent of the negativity."
Traders who participated in the survey expressed misgivings about decimalization nearly across the board.
Increased volatility
Only 3% of traders interviewed by Greenwich cited an improved ability to fill limit orders, while 82% said their ability to fill limit orders hasn't improved. And 76% of buy-side traders said the move to decimal trading has resulted in increased volatility in both listed and Nasdaq markets.
That finding stands in contrast to a Nasdaq report published in the summer on the initial effects of decimalization, which said decimal trading did not result in share volume or intraday market volatility.
According to Nasdaq, decimalization "has improved market quality" and "reduced transactions costs for investors, particularly retail investors." The exchange report concluded: "While there are clearly some areas of concern, we find no hard evidence that a one-cent quotation increment harms investors or degrades market structure on Nasdaq."
Institutional traders apparently disagree with many of the exchange's findings, but the Greenwich survey did validate one of them: that decimalization seems to have benefited retail and individual investors.
"Decimalization may offer an advantage to the retail investor," the survey said, "but on the institutional side, the impact has been more problematic."
That finding by Greenwich was "understandable" to Todd Eyler, senior analyst at Forrester Research Inc., Cambridge, Mass., who wrote a report last year on reducing equity trading costs.
He said trading in one-cent increments is a "pain point" for institutions since it allows more room for market specialists to step in front of market makers and profit from large block trades, which must be broken into smaller increments, usually at a higher cost.
"It's great for the day trader or retail investor but isn't helpful to large institutional traders," he said. "There are fundamental problems with decimalization."
Anonymous trading
In his report, Mr. Eyler said decimalization makes it easier for dealers to "front run" orders.
As a result, said Mr. Eyler, the market will move toward more anonymous direct trading between institutions. He said he expects dealers to move toward setting up "equity trading communities" like Liquidnet and POSIT. With anonymous trading communities, he said, "You don't have people stepping in and stealing your information."
