Stock Exchanges Trade Fractions for Decimals

The French have done it for hundreds of years and the British embraced it decades ago. But when it comes to quoting stock prices, the U.S. markets have avoided trading shares in decimals for more than 200 years.

Instead, stock prices, like weights and measures, haven’t changed since the early 1800s when stockbrokers in New York and Philadelphia happily traded securities in fractions, like eighths and sixteenths of dollars.

That’s about to change. On Monday, 13 stocks on the New York Stock Exchange and their associated options will start trading in dollars and cents.

The second phase of the pilot program at the NYSE begins Sept. 25 and includes 52 companies, representing 57 issues, including some of the Big Board’s most active stocks, such as America Online and Compaq.

The rest of the securities industry will embrace decimal pricing next spring — the deadline set by the Securities and Exchange Commission.

Concerning Decimals

U.S. markets happily traded in eighths and sixteenths until 1997, when more Americans than ever began to invest in the stocks. The House of Representatives then began to look into changing to a more easily understandable pricing system.

Earlier this year, the SEC ordered the NYSE and the Nasdaq to switch from fractions to decimal pricing by July 3. The transformation was halted to allow for any technical difficulties associated with the change to the year 2000.

But the Nasdaq’s parent, the National Association of Securities Dealers, cried foul, saying its computer systems would not be ready for such a swift move. In response, the SEC said it would leave the switch to the markets themselves. Now the timetable for decimalization has the NYSE and the Nasdaq implementing decimalization by April.

A phase-in approach was chosen because of the “laundry list of what needs to be working properly,” says John Panchery, decimals projects manager at the Securities Industry Association, an industry trade group. The slower implementation also allows companies, regulators and consumers to get up to speed, he adds.

More Volume

Those in favor of decimalization, including the Congress, say a more understandable pricing system is long overdue and will make markets more user-friendly. Most of those working in the markets, although not totally against the move to decimals, say it could present some short-term challenges.

One of these challenges is capacity, says Panchery. With stock prices quoted in increments of two decimal places (such as $0.05 or $0.01), as opposed to eighths and sixteenths of a dollar, brokerages and exchanges will experience massive increases in data traffic.

That’s because most stocks and options are currently traded at price variations of 1/16, which means there are sixteen price points, or “ticks,” at which an equity can be quoted or traded.

With decimalization, the variation between price points changes from 1/16 to a nickel ($0.05), so the number of potential price points in a dollar increases by 25 percent, from 16 to 20, and so on.

The ripple effect is an increase in trades, quotes, orders, cancellations and other message traffic, according to a SIA report on decimalization. Large amounts of message traffic could cause capacity problems, especially on high volume days.

Such a strain on capacity has been seen before. When the markets changed from quoting prices in eighths to sixteenths in June 1997, causing a 14 percent increase in message activity, according to the SIA report.

“The ripple effect will be felt all along the food chain,” says Panchery. “If companies have lots more quotes, more bandwidth is needed from the originator to the branch,” he says, adding that many brokerages have installed data connections with ten times the capacity of their older connections, and this has been a costly process.

Techno Burnout

Another difficulty for brokerages could be the cost of implementing new technology to handle the capacity, said Craig Pirrong, assistant professor of finance at Washington University in St. Louis.

Many brokerages are worn out financially from the many technological changes imposed by securities regulators in recent years — a list that includes the Order Audit Trail System, where brokerages must report all electronic orders for Nasdaq securities, and Y2K technology contingency plans.

“There has been a lot of systems work imposed on this industry, and people are getting to the point where they can’t put their resources in their own business, but have to respond to regulation,” says Deborah Mittelman, Instinet’s vice president of the execution services.

But most brokerages are prepared, says Panchery. Indeed, companies like Instinet, an electronic trading company that links up buyers and sellers, have worked to make sure they are able to deal with a capacity spike.

“We have studied the SIA’s recommendations and we used that to come up with own models to make sure that we have the capacity,” Mittelman says.