Reg NMS and Minimum-Tick Distort the Market in Opposing Directions : Theory and Market Experimental Evidence

We investigate the SEC Tick Size Pilot which mandated a 400% increase in minimum tick from 1 to 5 cents for small stocks. We predict and show that an increase in the minimum tick promotes venues operating inverted fee structures while Reg NMS promotes venues operating maker-taker fee structures. This is because the Reg NMS directs orders to the venue with the lowest displayed quotes – maker-taker venues with the highest make rebate to limit orders irrespective of take fees. By contrast, the minimum tick enforces uniformity in displayed quotes and thus directs orders to the inverted venue with the highest market order rebate. Both regulatory mechanisms are highly distortionary and cause the equivalent of water to flow uphill – the rise in the minimum tick results in a 60% relatively higher cost increase in inverted venues but, despite this, trading shifts from maker-taker to inverted venues