Tuesday, May 21, 2013 11:07:05 AM

Mini crash fuels calls for market structure overhaul

A 'mini flash crash' that wiped out the value of a US stock has again suggested US market structure distress, days after a roundtable saw captains of the finance industry agree that regulators should be careful not to interfere with a well-functioning system.

On Friday, the price of Anadarko Petroleum Corporation - which has a market capitalisation of US$45 billion - slid from US$90 to a single penny in the space of seconds, before returning to its pre-drop level.

Though it only impacted one stock, the Anadarko 'mini crash' echoed the 6 May 2010 flash crash that saw the Dow Jones Industrial Average plummet 1,000 points only to rebound minutes later. The Securities and Exchange Commission (SEC) subsequently undertook a five-month investigation to establish the cause, but many criticised the findings as being timid in the face of industry pressure to avoid reform.

More recently, the markets suffered a dramatic drop after a hacked Twitter account of Associated Press falsely claimed President Obama was injured after a fictitious White House explosions. This caused the Dow Jones to slide 145 points - 1% - before rebounding minutes later.

Faulty data

Joseph Saluzzi, US market structure expert and co-founder of agency broker Themis Trading, said Friday's glitch was most likely caused by corrupt market data, which was detected by automated market makers who immediately cancelled bids leaving only penny-per-share bids.

"The Anadarko event on Friday proves what the SEC has done since the flash crash has not worked and we're still subject to these mini flash crashes, and potentially a larger, market-wide flash crash," he said.

Saluzzi said the limit up-limit down (LULD) circuit breaker regime, which the SEC implemented in April across all US exchanges as part of measures to avoid future flash crashes, was not adequate in protecting the market. LULD effectively puts a price band around each security. If quotes appear outside of that band, trading is halted.

LULD was not called into action on Friday because its current phase one rollout does not include trading after 3.30pm. Saluzzi said this approach put buy-side firms that target the close in particular jeopardy.

"Institutional investors are concerned about systemic risk and this issue proves that regulators need to act. No one wants to turn back the clock on technology, but the SEC has shown it is not able to keep up," he said.

Cause for concern?

Friday's events came days after leading market participants met to discuss US equity market structure at a roundtable event led by US Representative Scott Garrett, chair of the House of Representatives sub-committee on capital markets.

The roundtable included participation from some 20 participants, largely from the sell-side and US exchanges, to discuss issues such as the future of Reg NMS and the effects of automated trading on market structure. According to a report from agency broker Rosenblatt Securities, panellists broadly agreed that US equity markets were in a healthier state, in part due to reduced trading costs for investors, than fixed income and OTC derivatives markets. 

Panelists said regulators planning a 'holistic review' of US market structure, which would likely include an evaluation of Reg NMS, should not drive large-scale change. Instead, pilot programmes for initiatives such as increasing trading among traditionally illiquid stocks, would be a better option, as electronic trading has largely benefit highly-liquid names.

Bill White, head of equities electronic trading at Barclays, did not attend the event, but said he concurred that US equity markets had shown resilience in recent years. He said Friday's Anadarko issue was not good for the market, but that did not mean there was a major issue with US market structure.

"So-called 'mini flash crashes' are generally caused by the types of isolated technology issue that occur in most industries," he said.

A wholesale review of Reg NMS would be positive for the market, said White, but he warned that sub-penny pricing for all stocks, not just those under US$1 as is currently in place, may have negative flow-on effects.

"It could cause capacity issues with a growth in message traffic potentially leading to significant costs and risks for the market," White said.