After the so-called flash crash of May 6, the Securities and Exchange Commission has elected to implement circuit breakers for automated-trading systems that would halt trading in shares experiencing price movements of 10% or more over a five-minute period.
A six-month trial begins this month and will apply to all S&P 500 stocks. Trading halts of five minutes will apply to shares experiencing such drastically rising or falling prices. SEC Chairwoman Mary Schapiro argued at a recent meeting that the May 6 crash was exacerbated by discrepancies in trading rules across exchanges and the changes are designed to address that.
The hope is that a pause in trading "would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price and resume trading in a fair and orderly fashion," according to the SEC's statement when the plan was unveiled.
During the six-month trial, the SEC is expected to make adjustments to the mechanism and to expand it to shares beyond the S&P 500, including exchange-traded funds, "as soon as practicable."
The SEC has been working with the national securities exchanges and the Financial Industry Regulatory Authority to craft the new rules. "I believe circuit breakers for individual securities across the exchanges would help to limit significant volatility," Schapiro said. "They would also increase market transparency, bolster investor protection and bring uniformity to decisions regarding trading halts in individual securities."
The New York Stock Exchange enacted circuit breakers after a major market crash in 1987. But those are based on movement of the Dow, not individual stocks, and result in a marketwide trading halt. Under that regime, a halt kicks in only after the Dow drops at least 10% before 11:30 a.m. Pacific Standard Time. The May 6 plunge happened later in the day and did not reach 10%, making those circuit breakers useless to do much to halt such a flash crash.
Still, traders are skeptical about the plan, particularly because they believe circuit breakers will likely kick in too frequently, they say. According to a Credit Suisse Group study published in late May, such a circuit breaker would have been tripped on nearly half of all trading days since the beginning of 2008. The breaker would have kicked in an average of about 40 times per day in October 2008 -- during the height of the credit crisis -- but fewer than 10 times per day over the full year, excluding the three months of intense crisis, Credit Suisse analyst Ana Avramovic wrote in a note.
While the proposal currently applies only to the large-capitalization stocks in the S&P 500, a similar rule put in place for more volatile small-capitalization stocks might make trading halts far more frequent. Small caps may require a customized set of rules to account for their typically larger swings, investors say.
Under the new plan, the exchange that lists the halted stock will handle the reopening of trading, according to published reports. But two of the biggest uncertainties about the new system are how the shares will react to the backlog of orders and how investors will react in that five-minute period.
The SEC also is working with exchanges to revise the
NYSE's marketwide circuit breakers. In addition, Schapiro has asked SEC staff to look at other preventive measures for large, fast-moving market shifts.
One area regulators are focusing on will be steps to deter or ban the use of so-called stub quotes, which are placeholder prices put on stocks when liquidity in the market dries up. Those quotes allowed some major stocks to sell for as little as one penny during the flash crash, even though it's unlikely anyone placed orders to buy at such low prices.
Regulators are also looking at whether electronic traders stopped trading during the 2:00 p.m. to 2:30 p.m. critical half-hour period and caused a liquidity drain.
Donna Block covers the Securities and Exchange Commission for The Deal.