The Securities and Exchange Commission (SEC) is reviewing market-wide circuit-breakers and individual ‘limit up-limit down’ mechanisms designed to prevent future ‘flash crashes’ to ensure the two measures do not interact adversely together.
In light of the present environment of high-speed electronic trading, the new circuit-breaker proposals, suggested by US exchanges and the Financial Industry Regulatory Authority (FINRA), propose to revise the existing market-wide circuit breakers, which halt trading in securities in the event of extraordinary market volatility.
The proposals were a reaction to the flash crash of 6 May 2010, where markets experienced excessive volatility in a short period of time and included recommendations from a joint SEC-Commodity Futures Trading Commission advisory committee.
They would replace the Dow Jones Industrial Average with the S&P 500 as the reference index and recalculate the values of the triggers daily instead of each calendar quarterly.
Existing circuit breakers require trading halts following three increasing levels of market declines – using 10%, 20% and 30%, respectively, of the average closing value of the Dow Jones Industrial Average.
Limit up-limit down
Currently pending before the Commission is another proposal to establish a new limit up-limit down mechanism to address extraordinary market volatility in individual securities.
The new limit up-limit down plan, which would replace an existing single-stock circuit breaker mechanism, would prevent trades in individual securities from occurring outside of a specified price band and would be coupled with a trading pause mechanism to accommodate more fundamental price moves.
A security would ostensibly enter a ‘limit state’ if its price moved a certain percentage – 5%, 10% or 20%, depending on the stock and time of day – over a 5-minute period, with a trading pause initiated if the market did not naturally exit the limit state within 15 seconds.
But after a public consultation period, the SEC is still concerned about how the two proposed measures will interact and is setting the wheels in motion to block the circuit breaker proposals until it is confident the measures can work together.
“The Commission shares the desire of the exchanges and FINRA to appropriately update the market-wide circuit breakers in light of the current market structure and the lessons learned from the events of May 6, 2010,” the SEC said in a regulatory filing. “Because of the importance of both the market-wide and individual security volatility moderators to the maintenance of fair and orderly markets and the protection of investors, however, the Commission believes the [exchanges’] proposals should be considered together with the proposed limit up-limit down plan, to help assure these mechanisms interact appropriately with one another, and that details of the market-wide circuit breakers are fully evaluated.”
The SEC is accepting public submission on the matter until 18 January.