It was nearly one year ago—on Aug. 24, 2015—that chaos struck the stock market. More than 1,200 stocks and exchange-traded funds suffered trading halts and subsequent pricing irregularities.
Market volatility that day was, in part, a by-product of fears regarding the Chinese economy that took root at the start of the trading day. The good news is that limit-up/limit-down protocols adopted by exchanges after the 2010 “flash crash”—intended as a sort of circuit breaker to freeze trading in times of extreme volatility and radical pricing swings—were triggered in an effort to prevent market-wide contagion. It was clear, however, that problems that day were exacerbated by inconsistencies in when and how exchanges responded.
Now, in response, three major exchange groups—Bats Global Markets, Nasdaq and the New York Stock Exchange –announced this week they are working together to harmonize their electronic trading procedures.
Among the critics blaming a lack of coordination and consistency regarding trading rules was the Investment Company Institute, a global association of regulated funds. In a November 2015 letter to the SEC it blamed “idiosyncrasies in the operation of the exchanges” for “avoidable confusion and uncertainty that contribute to market volatility,” urging the Commission to “address a lack of harmonization.”
“The severe price disruptions “exposed laws in the limit-up-limit down mechanism, including inconsistencies across markets for reopening trading in a security after a trading halt,” ICI wrote, adding that different reopening processes exacerbated volatility.
A March 2016 letter to the SEC—co-signed by like-minded asset managers, ETF providers, industry analysts, institutional and retail broker-dealers, and professional market makers—detailed their concerns.”Most market participants have reached a consensus on certain opportunities to improve existing market structure rules to limit the likelihood of a similar event occurring in the future,” they wrote. “Absent these changes, especially with the volatility in the current equity markets, we are concerned that the markets are susceptible to a similar event occurring at any time.”
Among those signing the letter were representatives of BlackRock, Cantor Fitzgerald, FactSet Research Systems, JPMorgan Asset Management, State Street Global Advisors, SPDR ETFs, and Vanguard Group.
“There are a variety of factors which contributed to the events of Aug. 24, including delayed openings, the influence of market and stop orders on the markets, and the interaction of market wide circuit breakers in times of extreme volatility,” they wrote, specifically citing lack of consistent LULD reopening procedures across exchanges and “clearly erroneous rules and procedures of exchanges which are not consistent with LULD.”
Among the recommendations: price collars on openings and re-openings should not impede price discovery; trading should not occur at any exchange or market center until the primary exchange has reopened the security and LULD bands are disseminated and applied; exchanges should be required to consolidate liquidity at the primary listing exchange during a LULD re-opening; and order imbalance information should be disseminated across the markets during reopening auctions.
Separate of additional efforts under consideration at each exchange, Bats Global Markets, Nasdaq, and the NYSE have now announced plans to file a set of exchange rules as well an update to the National Market System Plan to Address Extraordinary Market Volatility with the Securities and Exchange Commission. The current LULD Plan, approved on a pilot basis by the SEC in 2012 and is designed to prevent trades in individual securities outside of specified price bands, known as LULD Bands.
The exchanges’ goals are focused on four key areas: eliminating the time periods where securities could trade without LULD Bands in place; reducing the number of trading pauses; standardization of primary exchange automated re-openings following a trading pause; and the elimination of Clearly Erroneous Execution (CEE) rules when LULD Bands are in effect.
In a statement, the exchanges outlined joint-initiatives undertaken during the last year to meet these goals.
Leaky Band Protections
Working together, the three exchanges have, or are in the process of implementing, systematic protections to prevent trades in the interval between LULD halt resumption and the publication/receipt of new LULD Bands. This effort is designed to reduce subsequent trading halts and price dislocations.
Amendment 10 Implementation
The exchanges implemented coordinated changes to use the previous day’s closing price as the reference price at the open on occasions when no opening print is available on the primary exchange. Since the implementation of these changes, there has been approximately a 75 percent reduction in spurious LULD trading pauses.
Amendment 11 Implementation
All three exchange groups have finalized, and will be soon submitting to the SEC, changes to the LULD Plan that align parameters to improve the price discovery process after a trading pause.
Plans for Eliminating the Need for CEE Rules
The exchanges are considering market participant feedback to recommend changes to, or elimination of, CEE rules.