ETF providers are lobbying for tighter restrictions on market orders as regulators consider additional rules to avert another “flash crash.”
In some cases, firms such as
The Vanguard Group Inc. are pressing regulators to ban market orders for exchange-traded funds altogether — a move that broker-dealers and financial advisers oppose.
“Vanguard believes that the elimination of market orders on ETFs would afford a level of protection to investors,” said Martha Papariello, principal and head of the company's financial adviser services and ETF product management.
During the May 6 flash crash, the Dow Jones Industrial Average dropped 1,000 points — with hundreds of stocks briefly trading at close to zero — before rebounding within minutes. Many of those trades were later canceled, and more than two-thirds of them involved ETFs, causing regulators to investigate the funds' role in the event.
Many ETF providers, such as
Invesco PowerShares Capital Management LLC,
State Street Global Advisors and Vanguard, think that part of the problem stemmed from advisers' reliance on automated market orders, which are orders to buy or sell a security at the prevailing market price. The use of limit orders, which specify the price at which investors want to buy or sell, could have prevented many ETF trades from being executed at the wildly divergent prices that resulted from the volatility that day, experts said.
In the wake of the crash, the Securities and Exchange Commission and the
Commodity Futures Trading Commission set up a joint task force to investigate the causes.
In June, the SEC approved rules that require the exchanges and the
Financial Industry Regulatory Authority Inc. to pause trading in S&P 500 stocks when they experience a 10% change in price over a five-minute period. The SEC is seeking comments on whether that program should be expanded to include all stocks listed in the Russell 1000 Index, as well as 344 specified ETFs.
The SEC also is reviewing comments on another proposed rule it issued in the wake of the flash crash which is designed to set clear standards on when clearly erroneous trades can be broken.
Last Wednesday, the task force held a panel discussion with ETF providers and industry experts about whether regulators need to issue additional rules to address trading mechanisms that may have contributed to the flash crash.
REPORT PLANNED
The task force expects to publish a report on its recommendations and findings next month, Gary Gensler, chairman of the CFTC, said in opening comments at the meeting.
For their part, ETF providers are talking to SEC officials about how market orders played a role in the events of May 6.
“Market orders are bad,” Jim Ross, senior managing director at SSgA, said during an ETF industry panel discussion hosted by The
Charles Schwab Corp. in New York last Tuesday. “I am not quite at the point where I would say that market orders [for] ETFs should be abolished, but I am pretty close.”
BlackRock Inc., Invesco and Vanguard held meetings last week with the exchanges to discuss the issues related to the flash crash.
“If they were to say in the next six months, "Let's take these trades out and see,' I wouldn't be opposed to that,” said Benjamin T. Fulton, head of the global ETF business at Invesco.
Some broker-dealers and advisers, however, said that an all-out prohibition on market orders would hurt investors.
“Prohibiting market and stop-loss orders would be a big adverse, misguided and unnecessary overreaction to the May 6 market event,” Chris Nagy, managing director for order routing sales and strategy at TD Ameritrade Inc., said during the task force discussion. “We don't believe there is any factual data that these types of orders contributed to the problem.”
According to a survey of advisers released last week by BlackRock, most of those who responded aren't keen on changing order rules.
Of the 380 advisers surveyed, 63% said that the flash crash did little to change their use of stop-loss orders, and more than one-third said they strongly oppose a prohibition on such orders, which indicate the price at which a security should be sold to limit further losses. Stop-loss orders become market orders once the shares reach the indicated price.
Seventy-seven percent said that their usage of ETF market orders will remain the same.
“It would be a huge jolt to investor confidence to prohibit market orders for ETFs,” said Tom Lydon, a registered investment adviser and president of Global Trends Investments. “Imagine if all of a sudden, investors couldn't make market orders with ETFs, but they could with individual securities.”
One alternative to a prohibition on market orders that could be more palatable to advisers and broker-dealers would be implementing uniform price collars on ETFs, which would restrict how much an ETF could trade away from its net asset value.
Some exchanges, such as the
New York Stock Exchange, have such collars in place, but a uniform collar across all exchanges would make sense, ETF provider officials said.
“This is something that has worked in various forms and fashions, and has been very beneficial,” Kevin Cronin, director of global equity trading at Invesco, said at the task force meeting.
TWO-MINUTE HOLD
Another possible remedy would be instituting a “limit up/limit down” trading mechanism and place a two-minute hold on any stock that traded outside that specified price range, Noel Archard, head of U.S. products at BlackRock, said at that meeting. After the two-minute hold, the stock or ETF could continue trading.
The problem with collars and halting trading is that it hinders investors' choice, critics contend.
“I think what we need to look at is addressing the structure of the markets more,” Mr. Nagy said during the task force discussion.
Some ETF providers, such as BlackRock, think that there are less extreme solutions to the issue of market orders. For example, broker-dealers could make limit orders the default setting when investors place trades instead of market orders, which is the most prevalent default now, said Sue Thompson, managing director of iShares at BlackRock.
Finra is working with the SEC and the exchanges on a number of issues, including the role of order types in volatile markets, said Finra spokesman George Smaragdis.
E-mail Jessica Toonkel at [email protected].
