Overview of SEC Chairperson Mary Jo White’s Discussions with Stock Exchange Executives
Navi Mumbai, Maharashtra -- (SBWIRE) -- 09/20/2013 -- This Thursday, Securities and Exchange Commission (SEC), Chairperson, Mary Jo White, met and discussed with executives of stock exchanges about the recent trading glitches plaguing stock markets and their implications.
One may recall that last month, on Aug 22nd, NASDAQ had to halt trading, for almost three hours that included thousands of listed stocks and options like Apple, Intel and Facebook. The malfunction was just the latest in a series to affect equity markets. The preceding day, Aug 21, Goldman Sachs (GS) experienced a glitch that spammed exchanges with erroneous stock option orders, through its trading system. It could have cost more than $100 million for GS.
The case for Chicago Board Options Exchange (CBOE) is more akin to a “double whammy”. In April, the trading halted for more than three hours, while last Friday, Sept 13, its trading was down following a data feed error. These above incidents get dwarfed in comparison to the “Flash Crash” of May 6, 2010, the causes of which are still under intense debate. The incident highlights how algorithmic trading could cause stocks on Dow Jones to plunge nearly 10% within 20 minutes, momentarily vaporizing $1 trillion in market value.
Regulators like the SEC and Commodity Futures Trading Commission (CFTC) ever since have been cautious about the implications of algorithmic or high-frequency trading (HFT). In order to make futures markets less vulnerable to electronic glitches, fat-finger errors and manipulative strategies of trading firms, plans are afoot on the part of the CFTC to limit the orders an HFT firm can place in market and having firms identify/register as Automated Trading Firms.
By definition, HFT is the use of automated strategies (algorithms) to cater large order volumes in a fraction of a second. By 2010, speed trading accounted for almost 60% of all US equity volume. Notably, HFT pervades not only stocks but also futures, fixed income and currency markets. With the rise of HFT during the last decade, the noisy trading floors of the Chicago mercantile and futures exchanges and the New York stock exchanges slowly paved the way to ‘solemn’ trading desks at firms like Knight Capital Group, Citadel, Credit Suisse, to name a few.
Currently, algorithmic trading to a large part is carried by big firms known as proprietary trading firms and hedge funds. Considering the strategies they employ, oftentimes the distinction gets blurred. Given their expertise, resourcefulness and state-of-the-art tech preparedness, it is believed that these firms at least have a 10 microsecond lead ahead of their market counterparts in sensing and responding to trend changes in stocks.
However, what’s unnerving and uncomfortable to regulators like SEC and CFTC more than the mechanisms and modus operandi that HFT relies on, are the occurrences of glitches often referred to as ‘electronic snafu’ and the magnitude of the risk involved or money at stake. These occurrences or snafus provide fodder to the critics of HFT who infer that speed trading, particularly algorithmic trading, is inherently risky and dangerous.
Nevertheless, it’s not suggestive of the fact that noisy trading pits of earlier days were more efficient in managing risk and error-free. But, tiny errors, as they cascade through digital channels of today’s electronic trading, undoubtedly carry the risk to get amplified to enormous proportions. During the meeting with stock exchanges last week, the SEC discussed with them a list of items that the exchanges are expected to deliberate and return to the SEC in the next 60 days.
The list included the exchanges to provide an action plan ensuring their public data networks function properly in order to carry quotes and trades for NASDAQ and NYSE i.e. there should be standard testing procedures in place. In case of failures or any glitch in technology, a provision for a “kill or termination switch” should be considered allowing trading to be shut down by the exchange. In lieu, mechanisms for ‘making and breaking’ the stock trades during glitch should also be taken into account.
There has been some buzz around enforcing and implementing these standards and new rules by the SEC, referred to as Reg SCI. It’s an attempt on the part of the SEC to set up common standards and requirements for technology used in all stock exchanges. Such a regulation will help ensure technology at exchanges is continuously upgraded and tested, and have in place mechanisms to provide advance warnings and notifications in events of system glitch or disruption. The coming two-month period will show us what exchanges are proposing and responding to these arguments.
Also, opacity around ascertaining whether the glitch belongs to an exchange or a trading firm, and getting trading firms and hedge funds under the regulation ambit remains to be addressed. Thus it makes one wonder if the regulatory authorities can get their hands around them and rein in the risks involved with their practices.
As investors and traders, we all live in an electronic age and have to come to terms with the effects it carries. Developments like these could be viewed as potential improvements that might usher us into a new age of trading opportunities and investment patterns.
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