From the July 01, 2012 issue of Futures Magazine • Subscribe!

SEC approves new “flash crash” circuit breakers

The new mechanisms lower threshold for trading halts, and shorten trading halts

Earlier this month, the Securities and Exchange Commission (SEC) announced new circuit breakers designed to prevent the kind of extreme market volatility that led to the 2010 “flash crash.”

The proposals, which are to be implemented for a one-year trial period on Feb. 4, 2013, include a “limit-up/limit-down” mechanism and new market-wide circuit breakers. Both initiatives lower the thresholds that trigger circuit breakers and shorten the length of trading halts. They also measure market decline using the S&P 500 Index, rather than the Dow Jones Industrial Average.

The limit-up/limit-down proposal will stop trades at prices outside a specified band determined by a stock’s average price over the previous five minutes, ideally preventing erroneous trades from entering the system. The market-wide circuit breakers will halt all U.S. securities trading for 15 minutes if the S&P 500 drops by 7%, 13% or 20% before 3:25 p.m.

Miranda Mizen, a principal at TABB Group, says that the new regulations are focused on preventative, not after-the-fact, measures. “I think that it’s part of the continuing effort that we are seeing on behalf of regulators in general to shore up the market and improve investor confidence,” she says.

To be effective, Mizen says that the regulations must take the speed of the trading environment into account, or risk excessive market disruptions. “It’s modernizing the protective elements of the market,” she says. “You don’t want to keep stopping trading if you’ve got pockets of volume, but you don’t want to have big volatility.”

Jay Gould, partner at Pillsbury, Winthrop, Shaw & Pittman, anticipates that the proposals “[will] get absorbed pretty quickly,” provided that exchange brokers understand the new bands and trading stoppages, and that traders make the appropriate technological adjustments.

Gould expects that public input during this period will lead to additional changes. “It’s not like this is the last word,” he says. “If it doesn’t work; if experience shows that further revision is needed…the exchanges or somebody will step in,” he says.

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