The Securities and Exchange Commission is likely to consider imposing buy-and-sell obligations on electronic trading firms and other “high frequency” proprietary-trading firms that represent more than 50% of daily stock trading volume. Such firms are believed to have played a role in the stock market “flash crash” last May 6, Securities and Exchange Commission Chairman Mary Schapiro said today.
Broad stock market indexes fell more than 5% over five minutes in the violent market disruption four months ago and then rebounded almost entirely in 90 seconds. The disruption from that event — including cancelling by exchanges of more than 20,000 trades and sudden price movements of more than 60% in 324 securities — has exposed equity market structure gaps and raised serious questions about the integrity of the market and its price discovery functions.
Ms. Schapiro said she does not believe, as some traders argue, that May 6 was an aberration. The commission's boss cited comments from individual investors and their brokers to support her point.
“Retail broker-dealers have told us that their customers — individual investors — have pulled back from participating in the equity markets since May 6,” Ms. Schapiro said in a talk before The Economic Club of New York. “Indeed, according to mutual fund data, every single week since May 6 has seen an outflow of funds from equity mutual funds.”
While other factors may also be contributing to reduced participation in stock markets, the “trend is troubling, particularly if concerns about equity market structure are playing even a small role in investor decision making,” the SEC chairman said.
The SEC has taken initial steps to re-establish confidence. Those include circuit breakers that pause trading in stocks that move 10% or more within five minutes. The regulator has also proposed banning broker-dealers from giving direct marketplace access to very active electronic-trading customers, beefing up reporting requirements for those traders and banning them from access to so-called flash orders that may give them an unfair advantage.
But Ms. Schapiro said more needs to be done, particularly since high-frequency traders essentially have replaced specialists and other market makers on exchanges who, in the past, were obligated to make continuous, two-way markets in stocks. Indeed, the May 6 event highlighted the fact that rather than stepping in and buying or selling stocks when they were wildly gyrating, high-frequency trading firms using programmed algorithms pulled back or withdrew entirely from the market.
The SEC is preparing a report that likely will analyze the reasons that these firms abandoned their informal market-making roles and could require registration of very active trading firms as market makers. “The issue,” she said, “is whether the firms that effectively act as market makers during normal times should have any obligation to support the market in reasonable ways in tough times …. These traditional obligations have fallen by the wayside as the market structure evolved.”
She also said regulators need to improve the new circuit breaker mechanisms for individual stocks, as well as older ones for broad market changes, in part because anomalous trades can needlessly trigger halts that impede price discovery.
“Our next steps are likely to include a careful review of a limit-up/limit-down procedure that would directly prevent trades outside specified parameters, while allowing trading to continue within those parameters,” Ms. Schapiro said.
The SEC has already said it is probing the practice of many professional trading firms to flood the market with orders in order to test quotes. Many firms cancel 90% or more of the trades they submit, and the regulator is investigating whether the procedures involve fraud or other improper behavior. But Ms. Schapiro said such extravagant order stuffing, even if legal, may undermine fair and orderly markets As a result, the SEC will consider whether to impose new registration and trading requirements, such as one that would require a quotation to remain in force for a minimal period of time.
She also expressed concern about so-called “dark pool” trading venues that allow institutional investors to buy and sell stocks through venues provided by private firms and big brokerages such as The
Goldman Sachs Group Inc. and Morgan Stanley Smith Barney LLC. Those venues do not public display their orders. Though such trading now represents almost 30% of daily equity trading volume, up from about 25% just a year ago, dark-pool volume plummeted to 10% during the height of the May 6 disruption. “In a time of duress, the public markets were the ones that receive the flood of sell orders,” Ms. Schapiro said. “Can we expect the public markets to handle nearly all the order flow in tough times yet be bypassed routinely by a large volume in normal times?”
Although the SEC has been overwhelmed by the Dodd-Frank Act's requirements for it to complete some 105 new rules, more than 20 studies and establish five new offices, Ms. Schapiro said the agency will not retrench from its traditional role of ensuring that U.S. markets are structured to promote fairness, efficiency and transparency.
