For the first time in the modern era, issues related to the post-trade formation and dissemination of a consolidated quote brought trading in Nasdaq-listed stocks and equity options based on those stocks to a halt for approximately three hours on 22 August.
Unlike Nasdaq OMX’s infamous May 2012 Facebook initial public offering (IPO) failure, which involved Nasdaq OMX exchange systems and eventually cost the company US$10 million in fines from the US Securities and Exchange Commission (SEC), Thursday’s trading outage is thought to involve systems which route securities data to the exchange.
“Over the next few days, Nasdaq OMX is in the unenviable position of being seen by the public as the source of the problem, even though we do not know where the failure occurred,” explains Robert Stowsky, senior analyst with industry research firm Aite Group. “It could have been a problem at the securities information processor (SIP) or in one of the exchanges contributing data to the SIP.”
The role of SIPs in the US equities markets is to collect equity trade quotes and completed trade data for eventual distribution and publication.
In the case of Nasdaq OMX, it administers the SIP used to create the consolidated quote for Tape C securities, which consist of Nasdaq-listed equities, and is managed by the OTC/UTP operating committee, which represents the 12 US exchanges that trade Nasdaq-listed securities and the Financial Industry Regulatory Authority (FINRA) that operates the Trade Reporting Facility, which is used by alternative trading facilities (ATFs) to report their trades.
A separate industry organization, the Consolidation Tape Association, oversees the formation and dissemination of the Tape A and Tape B consolidated quotes, which consist of securities listed on the New York Stock Exchange (NYSE) and American Exchange (Amex) respectively.
“This is more a market infrastructure issue rather than a single-exchange issue,” adds Stowsky. “It just happens that Nasdaq OMX maintain the Tape-C SIP in this case.”
According to the limited information provided by Nasdaq OMX, which declined requests for comment, the SIP administrator began to notice a degradation in quote and trade distribution due to a connectivity issue. Nearly 75 minutes after Nasdaq OMX first identified the issue, the exchange halted trading in all Tape C securities. It then halted trading in all options trading based on those securities 12 minutes later. It was not until 51 minutes after Nasdaq OMX halted its trading of Nasdaq-listed securities that it implemented a regulatory halt in trading of all Tape-C securities.
The SIP managed to resolve the issue in 30 minutes, said Nasdaq OMX officials and began a phased re-start of trading at approximately 15:25 ET.
Although trade resumed prior to the closing bell, the industry and investors found it quite disconcerting.
“Any system that is as strategic to the operation of the US equities markets, such as a market utility like the SIP, that required 100% up-time should have had ‘hot’ failover capabilities,” said William Karsh, a special advisor at the National Stock Exchange (NSX). “Every system, which is critical to the US market system, should have this capacity.”
Karsh suggests that the SIP administrator or oversight committee put together plans or have processes in place to prevent similar events in the future. “If any participant acts in a manner that jeopardises a system’s performance and affects fellow users of the system, there should be a way to block the participant so that behavior does not cause the system to fail,” he adds.
The failure follows other serious technology problems for Goldman Sachs, which released a rogue algorithm on 20 August, which caused havoc with its options trading.
Goldmans’ algorithm sent erroneous options orders in the early minutes of the trading day and could cost the investment bank up to US$100m. Exchanges are currently in the process of identifying which order should be cancelled and the full cost may not be known for some time.
Regulatory knock-on
The trading outage comes at a time when the SEC is focused on trading systems and technology, having recently ended the comment period of its proposed Regulation Systems Compliance and Integrity (Reg SCI) on July 8.
If the regulation is implemented as written, it will replace the SEC’s voluntary compliance system for developing, testing and maintaining systems critical to the operation of the US equities market.
Aite’s Stowsky, sees the regulators sharing some culpability in the trading outage due to the SEC’s implementation of Regulation NMS, which created the current market structure.
Whenever there is an industry utility, it introduces a potential single-point of failure, he says and doubts if the distributed market structure has been tested rigorously.
“My experience in the industry is that organisations tend to squeeze the testing and quality assurance as they approach product delivery deadlines.”
Stowsky is also sure that politicians, and hence the regulators, will be following the reasons for the trade outage closely since it affects the perception of the US equities market as a fair and well run market.
“Anything that shakes that view will move to the top of their legislation or regulatory priority list.”