Joint CFTC-SEC "Flash Crash" Panel Calls for Market Overhaul

Discussion in 'Prop Firms' started by stockwrangler, Feb 18, 2011.

  1. Here come the recommendations - who knows when, how many, and in what form they will actually be implemented by market regulators:

    "Flash crash" panel calls for market overhaul
    By Roberta Rampton and Jonathan Spicer

    WASHINGTON/NEW YORK (Reuters) - U.S. regulators should stem the growing tide of anonymous stock-trading and consider charging high-frequency traders for their disproportionate amount of buy and sell orders, said a panel of experts advising how to avoid another "flash crash."

    The panel's 14 recommendations for U.S. securities and futures regulators contained some bold ideas that, taken together, would overhaul the high-speed electronic trading market.

    The advisers on Friday told regulators that today's markets can easily breed uncertainty among investors, and asked them to move urgently on the suggestions.

    Yet many of the ideas called only for "consideration" or "further study" -- potentially raising more questions as the first anniversary of the May 6 flash crash nears.

    "The recommendations are a good first step ... but from a practical standpoint of avoiding another (crash) in the future, it doesn't go far enough. I don't think it's possible to prevent another one from happening," said Adam Sarhan, chief executive of Sarhan Capital in New York.

    U.S. regulators were cautious about some of the boldest recommendations, including new fee structures to encourage liquidity and discourage high numbers of order cancellations.

    "I do not know where we as a commission would come down on fees," Securities and Exchange Commission Chairman Mary Schapiro told reporters after the panel meeting on its recommendations.

    The unprecedented May 6, 2010, market crash sent the Dow Jones industrial average down some 700 points before rebounding, all in a matter of minutes. It rattled investors, exposed flaws in the structure of markets, and set regulators on a mission to fix the system and restore confidence.

    The eight-member panel suggested the SEC consider forcing the banks, hedge funds and others that facilitate stock-trading away from the public exchanges to give investors a better price by a minimum amount.

    It also wants regulators to consider a way to better allocate the "costs imposed by high levels of order cancellations, including perhaps requiring a uniform fee across all exchange markets."

    That suggestion comes after regulators and others began raising questions this past summer about the massive amount of message traffic, or "noise" in the markets, and whether it allowed some high-speed, short-term traders to manipulate prices for profit gains.

    "What market regulation now has to do is limit uncertainty," said Maureen O'Hara, professor of finance at Cornell University and member of the flash crash panel. "You limit uncertainty by limiting the amount of movement a price can have before it falls off the map."

    The changes would require the SEC and fellow regulator, the Commodity Futures Trading Commission, to take on a massive amount of research and rulewriting at a time when the agencies are straining to carry out the Dodd-Frank financial reform law.


    While some have argued the crash was a freak event that called for obvious adjustments, such as the new "circuit breaker" trading halts, others said it was a wake-up call to finally get a firm handle on what could destabilize capital markets.

    It wants regulators to consider a so-called "trade at" order routing rule -- something that would hurt the growing ranks of "dark pools" where trading is done anonymously.

    Some 33 percent of U.S. stock-trading takes place away from exchanges, up from 20 percent four years ago. Some of the biggest internalizers are market maker Knight Capital Group Inc, bank Goldman Sachs Group Inc, and hedge fund Citadel.

    A "trade at" rule, which Schapiro on Friday expressed support for, would generally prohibit any of the dozens of U.S. venues and wholesale market makers from executing an incoming order unless they were already publicly displaying the best bid or offer in that particular stock.

    After the crash, one of the regulators' first steps was to form the committee to come up with some answers.

    Many of its ideas fall squarely in the "esoteric" category, though even small adjustments could revamp the flow of tens of trillions of dollars annually in the markets.

    The panel wants regulators to consider adjusting trading fees so that firms that provide liquidity get additional rebates that would help stabilize markets during stressful times; "depth of book protection" that would cut down on investors getting poor prices; and a closer look at "disruptive trading activities" in the futures markets.

    Other recommendations unveiled on Friday, such as expanding and modifying the "circuit breaker" trading pauses, had been telegraphed by regulators and mostly endorsed by market participants and exchanges such as NYSE Euronext and Nasdaq OMX Group.

    The exchanges at the center of the breakdown, however, added a new wrinkle to the debate when in the last week they set off a new wave of planned global mergers, including the takeover of Big Board parent by Germany's Deutsche Boerse.

    The mergers highlight the increasingly interconnected global marketplace, where drops in one region can rapidly trigger plunges elsewhere, and show how aggressively traditional exchanges are investing in newer, faster systems.

    "The whiz-bang technology in markets today means that when things go wrong, they go wrong very fast," CFTC Commissioner Bart Chilton said.

    (Reporting by Sarah N. Lynch, Jonathan Spicer and Roberta Rampton, with additional reporting by Ryan Vlastelica; Editing by Steve Orlofsky, Dave Zimmerman and Tim Dobbyn)
  2. Market Makers At Core of SEC-CFTC Report

    By Steve Dew and Olivier Ludwig | February 18, 2011

    Designing incentives for market makers in an era dominated by “high-frequency” electronic trading is one the crucial challenges in today’s financial markets, according to the latest report from U.S. securities regulators outlining ways to prevent a repeat of the “flash crash” of May 6, 2010.

    About 90 percent of all trading is now done by high-speed algorithmic computer trading, meaning the human element using the ‘open outcry' system is now largely a relic, Gary Gensler, the chairman of the Commodity Futures Trading Commission, said today to the joint committee of CFTC and Securities and Exchange Commission regulators who are looking into what went wrong during the flash crash.

    Gone with people working the floors of various exchanges are many of the market makers who were personally tasked with matching buyers and sellers in particular securities -- even when markets were roiled. Indeed, on May 6, the market was flooded by sell orders and market makers as well as high-frequency traders were, by and large, nowhere to be seen.

    “The Committee recommends that the SEC evaluate whether incentives or regulations can be developed to encourage persons who engage in market making strategies to regularly provide buy and sell quotations are 'reasonably related to the market," today’s joint report from the two regulatory agencies said.

    The committee’s findings and recommendations will be critical to exchange-traded funds, which were at the heart of the May 6 "flash crash." On that day, the Dow Jones industrial average lost nearly 1,000 points, or about 10 percent, between 2:40 and 3 p.m. Eastern time, only to rebound sharply and close down 3.2 percent on the day.

    ETFs, which now make up roughly a third of all equities traded today in the U.S., accounted for about two-thirds of the securities whose trades were subsequently canceled.

    Many ETF industry sources have told that high-speed computer-driven trading has cut profit margins for market makers, and therefore seriously curtailed their incentives for taking on the financial risks associated with providing trading liquidity in particular securities.

    The SEC-CFTC joint committee's report contains 14 recommendations, many of which have been in place on a pilot basis since the committee began its work last year, including single-security circuit breakers for the large-cap stocks in the Russell 1000 index as well as the most heavily traded ETFs.

    High-Frequency Trading Still A Boon

    The joint committee hastened to add, however, that high-frequency trading has been a boon for both institutional and retail investors, and noted that the rapid, high-volume movement of capital in and out of the securities markets has lowered transaction costs and contributed, for the most part, to enhanced price discovery.

    "The speed that allows markets to do things that scare us also allows markets to do things that heal quickly," said Maureen O'Hara, a professor at Cornell University's Johnson Business School and a member of the joint committee.

    "As we think about these sorts of circuit breakers and pauses, we have to recognize that just as liquidity can depart very quickly, it can come back just as fast," O’Hara said in the report.

    In his opening remarks, CFTC chairman Gary Gensler compared the effects of today’s high-speed algorithmic trading technology to the advent of the telegraph, which led to the ticker tape, and then the telephone. The phone allowed traders to obtain quotes instantaneously, and that was in 1929, Gensler said.

    "We need to adjust," he said.
  3. What's the stock market for again?
  4. A summary from the Themis Trading Blog:

    18 Feb, 2011
    CFTC – SEC Joint Commission Report Part Deux

    Summary of the Joint CFTC/ SEC Recommendations Regarding Regulatory Response to the Market Events of May 6th, 2010

    The report is out. Click here to read the 14 page report. The Joint CFTC/SEC committee makes 14 recommendations which they intend to focus on to ensure the integrity of our connected market place. We would like to highlight the 3 recommendations that we think are “news” today, and that we have particularly expressed concern about over recent years: Recommendations 10, 11, and 12, which deal with order cancellation fees, internalization, and trade-at rules.

    Missing in the report, however, is any discussion of proprietary exchange data feeds, the proliferation of exchanges, or minimum order life. Also, this report is a stark contrast to the September 30th report, which focused more extensively on an algorithm trading eMini futures from a large money manager. The HFT community, at that time, focused on that aspect of the report extensively. This report is an improvement, as it does begin to examine structural inefficiencies and risks in our current market structure.

    The Committee recommends that the SEC and CFTC explore ways to fairly allocate the costs imposed by high levels of order cancellations, including perhaps requiring a uniform fee across all Exchange markets that is assessed based on the average of order cancellations to actual transactions effected by a market participant.

    This is a win that they are recommending ANY type of cancellation fee. However we note that when you read the wording carefully, it will not be a recommendation for a fee on all cancellations; rather it will be a recommendation for a fee on cancellations that exceed a firms “normal pattern”. Lots of wiggle room here folks.

    11. The Committee recommends that the SEC conduct further analysis regarding the impact of a broker-dealer maintaining privileged execution access as a result of internalizing its customer’s orders or through preferencing arrangements. The SEC’s review should, at a minimum, consider whether to (i) adopt its rule proposal requiring that internalized or preferenced orders only be executed at a price materially superior (e.g., 50 mils for most securities) to the quoted best bid or offer, and/or (ii) require firms internalizing customer order flow or executing preferenced order flow to be subject to market maker obligations that requires them to execute some material portion of their order flow during volatile market periods.

    A related concern has to do with the effects.

    WOW. Look into obligations for internalizers too? While we don’t hold particularly valuable any of these affirmative obligation rules, it is nice to see that they are acknowledging how damaging the internalizer model has been.

    They also feel at a minimum that internalizers should price improve by 50 mils. This is an accommodation for crossing pools that tend to trade larger blocks, and when they trade sub-penny, they trade in the middle of the spreads (half a penny). THIS IS HUGE.

    12. The Committee recommends that the SEC study the costs and benefits of alternative routing requirements. In particular, we recommend that the SEC consider adopting a “trade at” routing regime. The Committee further recommends analysis of the current “top of book” protection protocol and the costs and benefits of its replacement with greater protection to limit orders placed off the current quote or increased disclosure of relative liquidity in each book.

    They want to look into protecting Depth Of Book! This is big also.

    Their other points, which were widely expected, follow:

    1. The Committee concurs with the steps the SEC (working with the Exchanges and FINRA) has taken to

    a. Create single stock pauses/circuit breakers for the Russell 1000 stocks and actively traded ETFs1

    b. Enact rules that provide greater certainty as to which trades will be broken when there are multi stock aberrant price movements, and

    c. Implement minimum quoting requirements by primary and supplemental market makers that effectively eliminate the ability of market makers to employ “stub quotes”

    2. The Committee recommends that the Commissions require that the pause rules of the Exchanges and FINRA be expanded to cover all but the most inactively traded listed equity securities, ETFs, and options and single stock futures on those securities.

    3. The Committee recommends that the SEC work with the Exchanges and FINRA to implement a “limit up/limit down” process to supplement the existing Pause rules and that the Commissions clarify whether securities options exchanges and single stock futures exchanges should continue to trade during any equity limit up/down periods.

    4. The Committee recommends that the CFTC and the relevant derivative exchanges evaluate whether a second tier of pre-trade risk safeguards with longer timeframes should be instituted when the “five second limit” does not attract contra-side liquidity.

    5. The Committee recommends that The Commissions evaluate the present system-wide circuit breakers and consider:

    i. reducing, at least, the initial trading halt to a period of time as short as ten minutes

    ii. allowing the halt to be triggered as late as 3:30 pm and

    iii. using the S&P 500 Index as the triggering mechanism.

    This makes immense sense. IT is not a Dow world, after all, and more importantly it is easier to coordinate the many S&P 500 related instruments.

    6. The Committee supports the SEC’s “naked access” rulemaking and urges the SEC to work closely with FINRA and other Exchanges with examination responsibilities to develop effective testing of sponsoring broker-dealer risk management controls and supervisory procedures.

    7. The Committee recommends that the CFTC use its rulemaking authority to impose strict supervisory requirements on DCMs or FCMs that employ or sponsor firms implementing algorithmic order routing strategies and that the CFTC and the SEC carefully review the benefits and costs of directly restricting “disruptive trading activities “with respect to extremely large orders or strategies.

    Algo providers may have an obligation to develop procedures, and have responsibility for, the actions of their clients, and how those clients interact with the algo technology.

    8. The Committee recommends that the SEC evaluate the potential benefits which might be gained by changes in maker/taker pricing practices, including building in incentives for the Exchanges to provide for “peak load” pricing models.

    Extra Rebates! Extra Fees! They will explore “what if” rebates were greater during times of stress, and “what if” it were more expensive to hit bids.

    9. The Committee recommends that the SEC evaluate whether incentives or regulations can be developed to encourage persons who engage in market making strategies to regularly provide buy and sell quotations that are “reasonably related to the market.”

    Will any mandated obligation outweight potential huge losses? Reasonably related to the market? How do they deal with a quote that can be cancelled before you hit it? Will firms like Getco have a huge advantage since their technology is the fastest (and their colo the best)?

    13. The Committee recommends that the Commissions consider reporting requirements for measures of liquidity and market imbalance for large market venues.

    14. The Committee recommends that the SEC proceed with a sense of urgency, and a focus on meaningful cost/benefit analysis, to implement a consolidated audit trail for the US equity markets and that the CFTC similarly enhance its existing data collection regarding orders and executions.

    This entry was written by sarnuk, posted on February 18, 2011 at 12:43 pm