Three leading US market making firms have written to national regulator the Securities and Exchange Commission (SEC) proposing stronger obligations for those providing two-sided markets.
The suggestions come in response to the so-called flash crash on 6 May, where US markets plunged in a matter of minutes. While a number of events are thought to have contributed to the sudden decline, no underlying cause has been identified.
“Combined with other market structure changes, additional market maker obligations will significantly reduce the chance of another destabilising market event like the one that occurred on May 6th,” read the letter from John McCarthy, general counsel, GETCO, Christopher Concannon, partner, Virtu Financial and Leonard Amoruso, general counsel, Knight Capital.
It has been suggested that market makers failed to provide liquidity on 6 May, subsequently exacerbating the decline. However, some market making firms including GETCO reported that they did not cease trading during the crash.
The proposals from the three firms are designed to place more stringent requirements on market makers in the US, and are centred on the quality of quotes provided by market makers.
These include a requirement for market makers to quote inside the spread for a minimum period of time during market hours and have minimum quoting size requirements, based on the price and average daily value traded of a stock. This will ensure that the liquidity provided by market makers is not too thin and offered at a reasonable price.
The group of market makers have also suggested rules that would improve the depth of liquidity on offer, by requiring market markets to provide between three and five price levels below the best price but within the circuit breaker levels implemented by the SEC last month.
There are also calls for market makers to implement a maximum quoted spread obligation – to eliminate the use of stub quotes – higher capital requirements for such firms, due to the associated risks of market making, and the need for each market maker to commit to proving liquidity in a minimum number of stocks.
Stub quotes are orders entered in at remote price levels by market makers when they do not want to fulfill their obligations to supply liquidity. The SEC is already reported to have mulled a ban on stub quotes in the aftermath of the 6 May events.