'Flash crash' triggers overhaul of trading rules

Stephen Foley
Wednesday 12 May 2010 00:00

Regulators promised an overhaul of US stock exchanges and so-called "dark pools", after ruling out human error for last week's 20-minute stock market crash.

The major exchanges have agreed to introduce uniform circuit breakers to halt all the trading in individual shares if there are sudden price movements, in the hope of preventing a repeat of the chaos and recriminations caused by last Thursday's 998-point plunge by the Dow Jones Industrial Average.

Market participants blamed a patchwork of different rules that mean trading halts on one exchange are not respected elsewhere, so that trading continues without clear prices being available. After deregulation in the past decade there are more than 40 places where shares are traded in the US, with the New York Stock Exchange and the Nasdaq stock market only the most famous among many. Investment banks and other companies have set up competing electronic trading platforms, known as "dark pools", where buy and sell orders can also be routed.

Eric Noll, executive vice-president of Nasdaq Transaction Services, testified before Congress yesterday that last week's plunge did not appear to be down to system failure or trader error. "Nasdaq continues to investigate but has at present located no 'smoking gun' that single-handedly caused or explains Thursday's events," he said.

The House of Representatives financial services committee is investigating the causes and lessons of what is being called the "flash crash". While the Dow had already slipped almost 400 points during the day, at 2.40pm it dropped a further 600 points in the space of a few minutes, before snapping back. For a few moments, trading screens showed that several multinational companies had lost 99 per cent of their value.

Early rumours suggested a "fat-fingered trader" had put a decimal point in the wrong place when entering a trade, and there was even speculation that the plunge had been the work of cyber-terrorists. However, the committee was told yesterday that the structure of the market was to blame, with high-speed computer trading exacerbating the volatility. It also seems that big moves in equities market futures can trigger even bigger effects on the equity markets themselves.

After the 1987 stock market crash, exchanges introduced circuit breakers that would halt trading if there were big movements across the market, but there are no equivalent rules on the trading of individual stocks. Major exchanges agreed on Monday to introduce such circuit breakers, which will be triggered simultaneously across all exchanges and dark pools, but the details are still to be hashed out.

Meanwhile, the Securities and Exchange Commission, which regulates the equity markets, and the Commodity Futures Trading Commission, which oversees futures markets, said they would work together to examine how the two sets of markets interact.

Mary Schapiro, the SEC chairman, also told the committee that the agency was examining if market participants with a responsibility to provide liquidity to the market stepped away from trading at key moments during the flash crash, and could be in breach of their duties. She said a wider review of trading rules will examine what kind of buy and sell orders should be permitted, including the practice of putting in "stub quotes" – requests to buy or sell at extreme prices, which are used by computer-based trading algorithms but which are not expected to become real trades.

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