New procedures for handling exchange outages proposed by the UK's Financial Services Authority (FSA) have been broadly welcomed, but cautious buy-side firms may still be reluctant to redirect their trading flow to multilateral trading facilities (MTFs) in the event of a market failure.
In Market Watch 36, the latest issue of the FSA's regular publication on market conduct and transaction reporting issues, the regulator outlines the steps trading venues and investment firms should take in the event of an outage.
These include the need for venues experiencing an outage to communicate with the wider market, i.e. member firms and other trading venues, in a way that is readily available and not misleading. “Good practice suggests that updates be provided at least every 30 minutes and whenever the venue operator changes the mode/status of its market or a restart has been scheduled,” read the newsletter.
The FSA also proposes that trading venues should set transparent limits when deciding at what point to restart a market, e.g. after a minimum number of member reconnections or a specific level of trading volumes, and calls for venues whose prices are widely relied upon for derivatives and index calculations to have established contingency arrangements to establish reference prices in the event of an outage.
“The FSA paper is a big step in the right direction,” Richard Balarkas, CEO, Instinet Europe, told theTRADEnews.com. “Many exchanges seem to take the view that they can handle a technical problem with impunity when in actual fact, the stance they are taking might be costing their clients a lot of money. Anything that encourages more transparency is a positive move.”
The last major exchange outage in Europe occurred on 26 November 2009 when the London Stock Exchange was forced to halt all order-driven executions on its platform for three-and-a-half-hours following connectivity issues.
During the outage all FTSE 100 and FTSE 250 stocks were placed into an auction-call period from 10.30 until 14.00, allowing members to amend or delete orders that were entered prior to being disconnected. This tactic drew criticism from the LSE's main MTF rival Chi-X Europe, which claimed at the time that the auction status “hampered investors’ ability to trade by not enabling participants to seek a reference price on another venue”. The LSE maintained that it went into an auction phase after consultations with clients to maintain an orderly market.
But while the FSA's latest guidance might help to clarify how trading venues should act during technical difficulties, the ability of investors to continue trading on alternative venues will largely depend on brokers' smart order routing (SOR) technology and investors' attitude towards MTFs.
According to Balarkas, brokers' SOR has continually developed to help clients find liquidity across venues regardless of glitches. “Our SOR does not need a live primary market in order to function,” he said. “This is something we have programmed in since fragmentation started to take hold in Europe and it allows our SOR to carry on trading in the event of a domestic exchange outage.”
Charles Taylor, execution partner at London-based agency broker Redburn Partners, says his firm's SOR, supplied by trading technology vendor Fidessa, is also designed to be venue agnostic, but highlights wider issues that may affect buy-side trading behaviour during an outage.
“Our SOR apportions trades relative to their market share on the venues we trade, so it will ignore a venue where there is no trading,” said Taylor. “However, buy-side clients may become more apprehensive about trading solely on MTFs in the event of an outage because of the perception that the primary market is an essential part of price discovery.”
Taylor also notes that if a venue with a dominant market share stops trading, benchmarks such as those that track the percentage of volume of a stock will not deliver an accurate reflection of market activity.
For MTF dark pools, such as Chi-X Europe's Chi-Delta and NYSE Euronext-owned SmartPool, which base their prices on a reliable reference market, the FSA paper suggests a suspension of trading activity in the event that the reference price is unavailable. For broker-operated dark pools, which also rely on reference markets, the paper suggests they should “have appropriate arrangements in place to ensure they continue to meet best execution obligations”.
The issue of how trading venues should handle technical problems was also highlighted during the 6 May 'flash crash' in the US.
During the precipitous stock price declines, NYSE Euronext activated its Liquidity Replenishment Points, a mechanism that slows down trading during volatile periods, with the aim of enticing more liquidity into the market. Subsequently, onward routing mechanisms used by US trading venues bypassed NYSE, resulting in even thinner liquidity for NYSE-listed stocks.