To celebrate our 50th issue of the magazine, The TRADE team looks back at the defining moments which have steered the industry and made it what it is today, for better or worse.
The Flash Crash
The afternoon of 6 May 2010 would later go down in history as “the Flash Crash” which saw trillions of dollars wiped off the price of stocks only for the market to rapidly recover in a half-hour market rollercoaster.
As the morning of 6 May wore on, negative sentiment began to build on markets, which saw increasing volatility and thinning liquidity. This was the catalyst when a large mutual fund complex initiated the sale of $4.1 billion of E-Mini S&P contracts. Settings for the algorithm used and the responses of high-frequency trading firms meant positions started to be rapidly passed back and forth and the price of E-minis dropped 3% in just four minutes.
This led to a cascade effect on other securities and derivatives contracts and leading spiralling losses in the market. Eventually automated stop systems kicked in and when markets reopened they rapidly recovered. However, the event highlighted some of the risks of automated trading algorithms and has led to increased regulation for algo providers and users and the venues which those algos trade on to prevent a similar event happening in the future.
Introduced in 2007 and much narrower in scope than today’s major European regulation, the Markets in Financial Instruments Directive was nonetheless a huge change in the way trades were conducted across Europe.
The regulation finally opened up European markets that had been completely dominated by a selection of incumbent national exchanges and ushered in a new era of choice and fragmentation. As a result of new legal structures such as multilateral trading facilities, a huge plethora of venues opened up across Europe. While many failed, a few have stuck around and become major players, including what is today knows as Bats Europe which has become the largest pan-European trading destination.
MiFID also helped to professionalise the industry by putting more responsibility on traders and introducing the idea of best execution, which would later be followed up with more force as part of MiFID II.
While not the only substantial failure by a listing venue, the IPO of Facebook was a fairly gargantuan and high-profile error by listing exchange Nasdaq, which would eventually result in tighter regulation for exchanges.
The shares in Facebook, one of the biggest tech IPOs ever, were due to start trading at 11am EST on 18 May 2012 but, due to a technical problem with Nasdaq, this trading was delayed until 11:30. This was the first of many technology problems to plague the IPO with many orders not going through and investors confused as to whether their order had gone through at all.
Despite an initial rally, the stock struggled to stay above its IPO price for the rest of the day and forced underwriters to buy back shares. Since the incident, there have been several other glitches at Nasdaq and elsewhere leading regulators telling exchanges to get a grip on their technology to keep market outages to a minimum.
What caused the flash crash? Well it could just be the people in Michael Lewis’s Flash Boys. This hotly anticipated book was an exposé of the world of high-frequency trading something which has been a crucial concern of the buy-side since it first came about with the advent of electronic trading.
The book follows several storylines but centres around the activities of Brad Katsuyama and Ronan Ryan (both of which are interviewed in detail this issue on page 44). The pair both noticed there was a problem with markets because genuine investors were struggling to fill their orders as prices kept moving away from them faster than they could react due to advanced trading algorithms deployed by proprietary trading houses.
The book stirred up considerable controversy, something which would be reignited this year when Katsuyama and Ryan’s IEX trading venue would go one to achieve exchange status in the US despite the protestations of big players such as Bats, NYSE and Nasdaq.
Can just a year be considered a defining moment? In the case of that most infamous of years, 2008, we can make an exception.
The year had already got off to a shaky start with markets beginning to stall and numerous concerns about sub-prime mortgages in the US and elsewhere. This ultimately came to a head in September 2008 when a liquidity crisis stemming from bad mortgage loans brought financial markets grinding to a halt, eventually claiming several victims, the biggest of which was Lehman Brothers.
The aftermath of that single event has perhaps been the biggest driver of the change the buy-side is now seeing. New rules focused on reporting of transactions, storing data securely and greater limits on bank balance sheets have markedly changed the way the world of finance operates. The light-touch regulation that dominated since the 1980s is now being pushed back in favour of much stricter rules that encompass many more areas, with knock-on effects on the cost of doing business.