The people who regulate the equity markets are moving with (for them) light speed on measures to combat, mitigate and decipher any future “flash crash” event. But it’s even more interesting to note the scant amount of resistance from money managers, brokers, traders and other officials most affected. Is such peace and harmony possible on Wall Street?
Regulators, including the SEC and various SROs, such as FINRA and the exchanges, are coordinating efforts to test, for roughly the next six months, a new system of market wide, individual stock “circuit breakers.” These are going to be five-minute time-outs that would be triggered for stocks in the S&P 500 when share prices rise or fall 10 percent in any five-minute period.
Most industry members feel these liquidity meltdown speed bumps are well intended, and that they just might head off another debacle like the one that caused P&G to nearly be taken over by Jim in the Institutional Investor mailroom, and for shares of Accenture to trade electronically for a penny when the last price quoted at the NYSE was around $40.
The NYSE has its own circuit breakers, that can be triggered by 2 percent moves and can last from a few seconds to a few minutes. The Nasdaq is contemplating similiar go-slow triggers, and there’s even protocol already in place going back to 1990 that can halt stock, stock futures and stock options markets when the Dow moves down 10 percentage points in a session; it was last triggered in the late 1990s when the trigger was set in point not percentage moves, which was considered back then to be an acceptable proxy for jaw dropping. That said, the market has never really coordinated such ambitious, proactive volatility intervention.
Hedge funds, an industry that contains controversial high-frequency traders suspected to be at the heart of the May 6 crash, are not putting up much of a fight on the pending circuit breaker pilot program. Stu Kaswell, Executive VP, managing director and general counsel for the Managed Funds Association, which calls itself the voice of the global alternative investment industry but which is best known as the hedge fund lobby, wrote to the SEC to say it applauded the effort, and that it considered a trial period an “intelligent approach.”
A read through some of the other comment letters submitted to the SEC shows that the majority of market participants have no strong aversion to the pending circuit breaker test run. Sure, there are some bonafide quibbles (a lawyer for Knight expressed concern about the overall unsettling direction of artificially trifling with volatility, a market maker’s best friend; and Vanguard is concerned about ETFs not being included in the initial trial) but no one is launching a major protest.
So apparently the gorillas in this game — the largest and fastest trading operations — are all good with this circuit breaker idea, which brings to mind the latest issue of II and a story by Mike Peltz. In an exhaustively researched piece, Peltz tackles the issue of high frequency traders.
Here’s one memorable exchange between Peltz, who used a first-person narrative style, and the iconoclastic Delaware Senator Ted Kaufman, who has adopted large, high frequency traders as a pet issue:
“We have a 300-pound gorilla in the room, and we’re saying that we’re going to keep it in a cage somewhere,” [Kaufman] told [Peltz]. “This thing will be 600 pounds.”
“But isn’t part of the problem that there are 300 gorillas?” I asked, referring to the fact that an estimated 200 to 400 firms do high frequency trading.
“Good point,” he replied. “We have all these gorillas, and guess what? We put them in zoos where the people running the zoos don’t have enough information and authority to take care of them.”
That priceless exchange might suggest that the article is anti-high frequency, but it isn’t. Like the circuit breakers, Peltz’s piece overall isn’t negative for these gorillas, and I’m not in a lather about that. But I’d at least ask, what of the smaller apes in the game, the retail investors — surely the circuit breakers are positive for them, right?
Not exactly. As mentioned earlier, Vanguard’s beef is that ETFs aren’t subjected to the speed bumps so there could be a situation between now and the end of the year where S&P stocks are halted for five minutes while the SPDR accepts an unholy beating. Market orders, a common way for retail investors to communicate buys and sells to their brokers, could also be vulnerable to a market that is melting with some stocks in limbo and others in hell.
And so here I would put forth, as some large comment providers noted on behalf of little guys, that the lack of limit up or limit down rules, as found in futures markets, should be addressed by the time the trial period is over.
And what of the idea to restore the uptick rule? I’m not sure it’s needed, but what is going on with that, and what do the gorillas think?
Often when regulators go to help small players they do so at the expense of large ones, such as mutual fund or pension fund managers who, in a cruel irony, are trading on behalf of millions of small players.
I’m kind of glad the gorillas are docile about the circuit breakers (although I’m also kind of skeptical and wondering why they are so quiet) however as the pilot veers though whatever comes our way in the second half of 2010 ($20 says an epic up move is cold showered around Labor Day) let’s not forget the lesser apes.
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