The Sub-Penny Opportunity

By Vlad Tenev, CEO and Co-Founder, Robinhood

The Securities and Exchange Commission under new Chairman Gary Gensler intends to propose new regulations to modernize market structure. Of course, we welcome the opportunity to engage in the conversation.

First Some Facts

The subject of Robinhood routing our customers’ orders to market makers rather than directly to the national exchanges has generated some controversy. Off-exchange market makers are able to provide our customers price improvement over the National Best Bid and Offer (NBBO), without charging exchange fees.

Here’s What We Think Could Change

The Sub-Penny Rule (SEC Rule 612) prevents exchanges from quoting in increments less than a penny. This limitation can result in an artificially wide NBBO, which is the pricing benchmark used by off-exchange market-makers.

In a nutshell, exchanges cannot fairly compete with off-exchange market makers in executing our customers’ orders. As a first step toward better enabling our exchanges to compete fairly, we propose amending Rule 612 to allow exchanges to quote prices up to four decimal places for all stocks.

Back in 2005, when Rule 612 was adopted, the consensus was that price increments of $0.0001 were economically insignificant. Supporters of the rule argued that sophisticated investors may use these smaller increments to step ahead of retail investors by trivial amounts. Some also argued that technology hadn’t advanced enough to properly handle an enormous increase in on-exchange quoting.

However, since that time, technology has advanced by leaps and bounds, and commission-free trading has become the industry norm. It’s now clear that customers value sub-penny price improvements and no longer consider them economically insignificant, especially in low-priced, high-volume stocks that may only trade with a penny spread.

Chairman Gensler noted in a speech earlier this month that market makers - also known as wholesalers - are able to transact in sub-penny increments. “As a result,” he said, “wholesalers may operate on an unequal playing field when competing for order flow.”

Let’s try to level the playing field.

If the sub-penny limitation is removed, and exchanges reduce fees for retail orders, we could see a tighter NBBO, even better execution quality for retail investors, more transparency and perhaps more retail order flow executed on lit markets.

It’s not lost upon us that brokers, including Robinhood, and other financial institutions benefit right now from spreads being wider. Others may not advocate for this proposal, but Robinhood will continue to fight for what we believe is right for customers and the long-term health of the markets.