India flash crash study calls for exchange overhaul
Stronger exchange-level controls to halt trading should be implemented on Indian exchanges to avoid a repeat of the crash that occurred on the National Stock Exchange (NSE) this month, a new report
The Nifty index, comprised of the top 50 stocks on the
NSE, dipped by US$70 billion after a fat
finger error caused the index to slide.
Although index-level circuit breakers were tripped and halted trading for 15 minutes, orders sent before the break were executed when the market
opened again, forcing the entire market down by 16%, only to recover minutes
Hirander Misra, co-founder and non-executive director of
Forum Trading Solutions, a provider of trading platforms, and co-author of the report, warned conventional circuit breakers in India need to be overhauled.
The ideal structure should incorporate a range of
fail-safes that are built into the systems of India’s major bourses,
including a halt mode that stops all trading, and an individual halt mode that
isolates problem stocks, according to the research.
“During the halt mode period you would ideally allow no new
entry and no execution on the central order book and a pause of in-flight
orders, while allowing members to cancel their own orders,” Misra said, adding the specific-stock option would cause less problems throughout the market,
allowing brokers to remove orders from their systems.
“The individual stock halt mode could isolate the
potentially catastrophic effect and make sure nothing else has a dependency on
those orders, essentially eliminating any knock-on effect,” Misra said.
The report also recommends increased market supervision with
new surveillance tools, and highlights the fact that NSE system has only
undergone upgrades, not a major overhaul, since 1992.
When the 5 October flash crash occurred, many speculated the
rise in algorithmic and high-frequency trading (HFT) was to blame, although the
rise in computer-based trading will necessitate stricter exchange controls,
according to Misra.
“Algo trading and HFT isn’t inherently bad. It’s not the
volume of orders that’s the problem, it’s about having the right level of
monitoring and controls in the core system.
“Any well-designed modern system with the right checks in
place should be able to handle high volumes and unexpected market events,”
Despite the Securities and Exchange Board of India launching an investigation into the crash, the regulator is yet to announce any rule changes that would add further fail-safes into the system.
The India flash crash draws parallels to the 2010 US flash
crash that saw the Dow Jones Industrial Average to plunge by 9% within five
minutes, due to an unconstrained algo trade deployed by a mutual fund, only to recover the majority of losses 20 minutes later.