US regulator the Securities and Exchange Commission (SEC) and industry body the Financial Industry Regulatory Authority (FINRA) have confirmed plans to establish a new ”limit up/limit down' mechanism to address extraordinary market volatility in US equity markets.
Under the proposal, trades in listed stocks would have to be executed within a range tied to recent prices for that security.
If approved by the SEC, the new limit up/limit down mechanism would replace the existing single stock circuit breakers, which were approved 16 June 2010 on a pilot basis shortly after the ”flash crash' of 6 May.
This week, US exchanges filed to have the existing circuit breaker pilot extended for a second time by four months, which would take it past 11 April, its original end date, to 11 August 2011. The current pilot scheme – which imposes a halt on trading in an individual stock for five minutes in the event of it falling or rising 10% or more in the previous five-minute period – had been scheduled to terminate on 10 December.
The SEC has approved the extension, although if the limit up/limit down rule is approved prior to this date, it will be replace the existing circuit breaker pilot. The regulator will seek comment on its plan, which is subject to commission approval following a 21-day public comment period.
The proposed ”limit up/limit down' mechanism would prevent trades in listed equity securities from occurring outside of a specified price band, which would be set at a percentage level above and below the average price of the security over the immediately preceding five-minute period. For stocks currently subject to the circuit breaker pilot – those in the Standard & Poor's 500 Index and Russell 1000 Index – the percentage would be 5%, and for those not subject to the pilot, the percentage would be 10%.
The percentage bands would be doubled during the opening and closing periods, and broader price bands would apply to stocks priced below US$1. To accommodate more fundamental price moves, there would be a five-minute trading pause – similar to the pause triggered by the current circuit breakers – if trading is unable to occur within the price band for more than 15 seconds.
If approved, all trading centres, including exchanges, automated trading systems and broker-dealers executing internally, would have to establish policies and procedures reasonably designed to prevent trades from occurring outside the applicable price bands, to honour any trading pause, and to otherwise comply with the procedures set out in the plan. The exchanges and FINRA have requested that the SEC approve the plan as a one-year pilot program.
“Upgrading our trading parameters will help our markets retain the confidence of investors and companies,” said Mary Schapiro, chairman of the SEC. “We were focused on improving the structure of our markets before weaknesses were exposed on 6 May, and we will continue to be focused on market structure going forward.”