A three-year effort to fine-tune curbs on volatility for individual stocks enters a new phase today in the U.S.
Trying to reduce market disruptions, regulators are instituting a plan that creates price bands in which shares are allowed to trade on American equity exchanges, replacing the old system of immediate pauses when shares swing rapidly. New restraints to halt all U.S. stock, options and index futures when the Standard & Poor’s 500 Index plunges will also take effect. Both will operate as one-year pilot programs.
Regulators and exchanges are altering the speed bumps adopted after the May 2010 flash crash to boost confidence in a market that has become faster and more complex over the last decade. While replacing automatic halts with the new system known as limit-up/limit-down is “the right answer,” getting ready for it hasn’t been easy for broker-dealers, according to Chris Concannon, a partner at electronic market-maker Virtu Financial LLC in New York.
“It adds more complexity,” Concannon said. “It sounds simple, but for firms managing thousands of customer orders, you have to program how you’ll manage them, how you’ll deal with quotes and trades across 50 destinations, routing decisions and execution quality.”
Under limit-up/limit-down, trades won’t be permitted to occur more than a specified percentage above or below a stock’s rolling five-minute average price. If the lowest price at which investors are willing to sell shares reaches the stock’s lower band, or the highest purchase price reaches the higher band, the stock enters a so-called limit state for 15 seconds. Should no trades occur between the bands, trading will cease for five minutes, according to the U.S. Securities and Exchange Commission.
More than two dozen companies listed on exchanges owned by NYSE Euronext, Nasdaq OMX Group Inc. and Bats Global Markets Inc. will adopt the new trading bands today. More will join each week through mid-May until all S&P 500 and Russell 1000 Index corporations and more than 400 exchange-traded products are included in the revised program.
The curbs will operate from 9:45 a.m. to 3:30 p.m. New York time. Other securities will be added in August, when the program will also run the full day from 9:30 a.m. until 4 p.m.
“There’s going to be some hiccups,” Adam Sussman, director of research at consulting firm Tabb Group LLC in New York, said in a phone interview. “Where it’s going to get tricky for brokers is how they handle responses to when a stock is in a limit state.”
U.S. stock exchanges and the Financial Industry Regulatory Authority, which oversees almost 4,300 brokers, introduced curbs for individual stocks after the flash crash to halt shares when they rise or fall at least 10% in five minutes. The new system is likely to cause fewer halts, the SEC said last year.
The so-called single-stock circuit breakers were triggered 550 times between June 2010 and December 2012, according to a March 27 report by Ana Avramovic, a New York-based analyst in Credit Suisse Group AG’s trading-strategy unit. Of these, 51% were stops in very illiquid or cheap stocks, 40% were driven by news about the company and 6 percent were caused by what are called fat-finger events or accidental trades. Only 4% were triggered by a single bad transaction, and with the new initiative “we would expect that percentage to decline,” Avramovic wrote.
The percentage a stock can move is determined by its closing price the previous day. S&P 500 stocks that are more than $3, for example, can move 5% above and below their rolling average price. The range is bigger for cheaper stocks.
The plan also gives the market that lists a security the discretion to declare a trading pause when a stock has “deviated from its normal trading characteristics” and the exchange decides that a halt would curtail excessive volatility, the SEC said. That will ensure a company’s shares don’t “remain impaired” indefinitely, it said.
Testing for the volatility-reducing programs occurred on several Saturdays and included broker-dealers, all market centers and the so-called securities information processors that disseminate data, Louis Pastina, executive vice president for market operations at the New York Stock Exchange, said by phone. The tests were scripted to trigger events such as limit states and halts so firms could ensure they can handle the data properly, he said.
Phasing in the new curbs “gives the industry time to digest this in small bites until later in the summer when all stocks will be included,” Pastina said.
NYSE and NYSE MKT, the exchange operator’s platform for smaller companies, are ending their liquidity replenishment points, or automated curbs that pause trading only on those markets, as the new curbs are installed for specific stocks. LRPs, introduced as a safeguard when NYSE converted to a more fully electronic exchange about half a dozen years ago, are being ended after the SEC told the company to eliminate them to avoid confusion once the new brakes are in place.
NYSE canceled no trades during the flash crash on May 6, 2010, while other exchanges voided more than 20,000 transactions totaling 5.5 million shares, according to a report by the SEC and Commodity Futures Trading Commission in October 2010. More than 1,000 companies triggered LRPs lasting more than a second between 2:30 p.m. and 3 p.m. on May 6, compared with 20 to 30 on most days, the report said. Some exchange and brokerage executives said NYSE’s actions may have caused liquidity to move to other venues and created confusion in the market.
The speed of quote and trade data dissemination has increased since the the flash crash, when it generally averaged about 10 milliseconds, or thousandths of a second, according to the SEC. During several minutes of high volatility on May 6, the price information was delayed by as much as 35 seconds, causing concern about data integrity among market participants, who may have reduced the liquidity they supply through bids and offers, the SEC and CFTC report said.
NYSE Euronext’s average latency or time to process public data for all securities listed on exchanges other than Nasdaq Stock Market was less than 1 millisecond in the fourth quarter, compared with less than 3 milliseconds two years earlier, according to a notice. Nasdaq OMX Group Inc.’s average latency for public quotes and trades in Nasdaq-listed stocks was less than 2 milliseconds in the fourth quarter, the notice said. Quotes were processed in less than 4.5 milliseconds and trades in less than 6 milliseconds two years earlier.
The SEC has also revised the marketwide circuit breakers that halt all trading, created in the aftermath of the October 1987 crash, because they weren’t triggered during the May 2010 rout. The alterations will make the curbs “more meaningful and effective in today’s high-speed electronic securities markets,” the agency said when it approved the changes last year.
All U.S. securities trading will halt for 15 minutes when the S&P 500 falls 7% or 13% before 3:25 p.m. The lowest trigger was previously a 10% drop in the Dow average. The proposal also shortens the length of most halts and modifies the times when the circuit breaker can be triggered. A plunge of 20% will cause all trading to stop for the day. An industry-wide halt was triggered once, on Oct. 27, 1997.
The revised curbs are in effect for equity-index futures on the Chicago Mercantile Exchange and Chicago Board of Trade to ensure that prices in the related derivatives markets remain linked to stocks, Michael Shore, a spokesman for CME Group Inc., said in an e-mail. They will also apply to Russell equity futures traded on Intercontinental Exchange Inc., the company said in a notice on March 28.
CME and the Securities Industry and Financial Markets Association urged the SEC to allow marketwide curbs to be triggered if a sufficient number of individual stocks are halted since that may affect the calculation of indexes. The SEC said market participants could submit comments about this issue while the programs are being tested.
How curbs for individual securities will work in conjunction with those that halt all futures and securities trading is “poorly understood,” CME told regulators last year.