View from City Road: Making the small fry count

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The Independent Online
THE Stock Exchange could halve in size without any significant loss of value. This apparent conundrum is a truism because half of all quoted companies account for 98 per cent of the market's value and volume. The rest barely count. Their shares rarely change hands, they are poorly researched and they cost too much to deal in.

The exchange has tried, and failed, to improve liquidity. First, it persuaded a handful of market-making firms to promise that two of them would make markets in each and every company, however small. Volumes stayed stubbornly low. Then it allowed only one market-maker per stock. Volumes were unchanged. Then it introduced a bulletin board allowing would-be investors to advertise their interest. Volumes failed to rise.

Six months later it is replacing the bulletin board with the Stock Exchange Alternative Trading Service (Seats). This will combine the last two systems - single market- makers and the bulletin board. Why they should work better together than they did apart is hard to see.

Plainly, the Seats launch was not enough for UBS Phillips & Drew, which chose yesterday to announce plans to stop market- making in about 200 stocks. It is also making 15 staff redundant. P&D was following Warburg and County in cutting back their exposure to smaller companies.

The only hope is that the exchange's concessions will persuade other market-makers to continue using their capital in this market. Market-makers will have sight of agency crosses - deals between agency brokers - and will not have to disclose deals until the next day. These rule changes please Winterflood Securities, one of the most vocal critics of current arrangements.

While that may take the pressure off the exchange, it will not make much difference to investors. Two things are needed to encourage them to buy shares in tiny companies. Costs of dealing should come down. The spreads - the difference between the bid and offer prices - represent 14 per cent of a small company's share price against 2 per cent for an FT-SE 100 stock.

More importantly, there would be more interest in these companies, which are predominantly domestic, if the economy were stronger. The introduction of Seats has done nothing to change that.

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