The report being compiled on the 6 May ”flash crash' by the Securities and Exchanges Commission (SEC) and the Commodities and Futures Trading Commission, the US regulators responsible for trading of securities and derivatives, is expected this week.
In addition to analysing the causes of the crash, the report could offer recommendations on preventing a re-occurrence with limits placed on trading technology and tougher rules on electronic market makers.
The flash crash saw the US stock market plummet, with the Dow Jones Industrial Average falling almost 1000 points to 9,869.62 points, before finishing the day at 10,520.32, 3.2% down on the previous day.
The effect on the US market has been significant. On 10 June the SEC implemented a circuit breaker scheme, which halts trading in any S&P 500 stock if its price deviates by 10% in a five-minute period, for a trial period until 10 December 2010. This was extended to components of the Russell 1000 index and some exchange-traded funds on 13 September, with new rules enabling the breaking of trades for stocks worth $25 or less if the trades are at least 10% away from the circuit breaker trigger price, 5% for stocks priced more than $25 to $50, the figure is 5%, and 3% for stocks priced more than $50.
A white paper published by agency broker Themis Trading on 24 September noted that data from the Investment Company Institute suggested nearly $57 million had been withdrawn from US stock mutual fund by investors since the crash, while average US trading volumes for Q3 are down 25% from Q2 and down 15% year-on-year.
The SEC will use the results of the report to create a more stable market structure and try to restore trust in the market. Algorithmic trading and high-frequency trading has been a major source of investor concern. Speaking before the Security Traders Association on 22 September, chairman of the SEC Mary Schapiro drew attention to the dangers that technology-enabled trading posed to the market, noting that, “One of the new, individual stock circuit breakers was triggered when an algorithm attempted to execute 10% of the stock’s average daily volume in two seconds.”
Her remarks suggested that the report could address pre-trade risk management, which the Market Access Rule – proposed on 19 January 2010 – was intended to tackle. “Even with checks for ”fat finger' errors and other problems, these algorithms can quickly generate a volume of orders that swamps the immediately-available supply of liquidity for a stock,” she said.
Schapiro continued, “We need to consider whether these relatively new trading tools are subject to appropriate rules and controls. For example, are algorithms programmed with appropriate throttles that prevent them from operating in an unintended manner? An out-of-control algorithm not only can cause serious losses to the firm that uses it, it can also cause severe trading disruptions that harm market stability and shake investor confidence.”
The Themis Trading white paper suggested that the SEC would alter the existing single-stock circuit breaker to include a limit up/down feature, eliminate stop-loss market orders, eliminate stub quotes and allow one-sided quotes and an increase of market maker requirements, including a minimal time for market makers to quote on the nearest best bid offer price.
However, SEC Commissioner Troy Paredes, speaking on his own behalf at the Security Traders Association Annual Conference on 24 September, questioned the value of obliging a high-frequency trader to provide liquidity to the market saying that in times of crisis no obligation would stand up. “To the extent imposing market maker obligations on high frequency traders would not, in practice, meaningfully induce liquidity when it is needed most, is burdening liquidity providers with such regulatory responsibilities warranted?” he concluded.
The report is expected to be released by 30 September.