After last month's troubled Facebook IPO, representatives from leading US equity exchange operators called for market-wide reforms to restore investor confidence at the SIFMA Tech Leadership Forum in New York.
The panel, which comprised representatives from NYSE Euronext, BATS Global Markets and Direct Edge, as well as agency brokerage and technology provider ConvergEx Group, were careful not throw stones at Nasdaq OMX, which experienced a technical problem resolving the opening cross for the Facebook IPO on 18 May.
Rich Repetto, principal at Sandler O'Neil & Partners and panel moderator, noted that Nasdaq OMX had not been able to provide a spokesperson and steered the discussion toward the impact that the event had on the markets and ways to mitigate such ‘black swan’ scenarios in the future.
The Facebook IPO is just the latest event to shake the confidence of investors in the US cash equities markets said the panelists. Two months earlier, BATS suffered its own technical problems, which led the exchange operator to put its own IPO on hold.
“We did stumble across the stage as we were reaching for our diploma,” said Chris Isaacson, COO of BATS Global Markets. “However our situation was different. We could not print to the tape for 30 minutes, so we stopped trading. Within another hour we were set for another auction, but decided to pull the IPO.”
However, investors have not bounced back as quickly and no US company has launched an IPO since Facebook.
“It was a dramatic event for everyone,” said panelist Joseph Mecane, executive vice president and co-head of US listing and cash execution at NYSE Euronext. “Overall, this is largely a black eye for the industry.”
Anatomy of a failure
Nasdaq OMX officials publicly cited a malfunction of the exchange's continuous IPO cross, which determines the opening price of a newly listed stock, as the cause of the problem.
Typically the system takes in pre-trading orders for the IPO stock right up to the point that the platform take a snapshot of the book to determine which opening price would match the most orders.
When Nasdaq OMX attempted to take the automated snapshot at 11.00 local time on 18 May, too many orders were still coming into the system, which prevented the cross from happening.
“They had a chase error, or continual loop,” explained Repetto.
For the next 10 minutes, the exchange went into its emergency routine and moved all of the pre-trade orders received up to 11.10 on to a second server to determine the opening price while the first server continued to receive order cancellations. After 20 minutes of back testing the results of the cross and communicating with Facebook’s underwriters, Nasdaq OMX began trading the stock at its now-infamous US$42 per share. Yet it took the exchange until 1.50pm to send out the trade confirmations for Facebook trades.
“Traders went without order confirmations for approximately two and half hours, which is a big problem,” observed Repetto.
Nasdaq OMX has since laid out its plans for compensating members that lost out because of the technology error, but has come under fire from other US bourses because part of its proposal includes the reduction of trading fees.
Unlike the 6 May 2010 flash crash, which affected the entire equities marketplace, an IPO glitch really only affects the market where the company is listed, explained BATS’ Isaacson. “The rest of the exchanges are just hanging around the periphery.”
As such, the issue is more about disseminating information to the other market centres about the status of trading.
“This was an industry failure, technology failure and a crisis management failure,” stated panellist Joseph Cangemi, head of equity sales and trading at ConvergEx Group.
“What we need is a hotline for these major watershed events,” added Bryan Harkins, COO of Direct Edge. “An exchange might take a PR beating, but without the proper communications it could harm investor confidence in the long term.”
NYSE Euronext's Mecane suggested that there were already a number of points at which an exchange could stop trading on a stock, including for technical problems and when material news is about to be announced, proposing that the industry should look to add another market-wide capability allowing to exchanges to halt IPO trading in the event of a technology-related problem.
None of the panellists believed that the industry would be able to deploy such a market-wide solution in the near future to prevent similar situations.
“Exchange competition may bring quote spreads down, but it also makes quick market-wide solutions difficult,” noted Cangemi. “The US Securities and Exchange Commission only voted on 31 May to have all the exchanges implement limit up-limit down trading controls by 4 February, 2013. And that was addressing the flash crash in 2010.”