There’s a danger lurking at the heart of the London market for smallcaps, one which, if not addressed soon, could imperil London’s status as an attractive place for smaller companies to list compared to markets like Toronto and Australia.... We are of course talking about “fat spreads”. As most readers will know, bid-offer dealing spreads are the difference between what an investor pays for buying the shares and what the seller gets for disposing of them at a particular point in time. When there are lots of buyers and sellers (i.e. when a stock is “liquid”), competition forces the bid and offer closer together so that this difference for a stock like Barclays is insignificant. Unfortunately the situation is very different for most AIM and PLUS stocks. If a share price is quoted at say 16p-20p, then a smallcap investor knows that, as soon they buy a share, they could be 20% down. High dealing spreads like this can deter investors, which creates a dead-weight loss for both companies and investors.
The issue is that that the bulk of small-caps still use the old Stock Exchange Automated Quotation system (“SEAQ”). Most Main Market and the largest Aim shares are traded on the order-driven SETS, SETSqx and SETSmm platforms. SETS is the LSE's proprietary electronic order book for the the most liquid stocks, which works by matching buy and sell orders electronically. In practice for traders, SETS means that the order book is open to the public. An individual investor can put an order on the book using a direct market access share account (e.g. via iDealing or IG Markets).
In contrast to this, SEAQ is the London Stock Exchange’s non-electronically executable quotation service that relies exclusively on specialized and competing dealers also known as market-makers. Market makers (or ‘jobbers’ as they were once known) were formerly the exclusive wholesalers of the stock market. SEAQ stocks need to have at least two market-makers who are obliged to offer to buy and sell shares to investors at all times. SEAQ effectively gives a monopoly over all of the incoming orderflow to the market makers since members of the public cannot submit limit orders which can match with each other.
The idea behind SEAQ is that individual investors should always be able to trade and that the element of competition between market-makers should lead to narrower dealing spreads and a hunger…
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