Should more be done to prevent another computer-driven crash?
When new circuit breakers were put in place following the flash crash of May 2010, they were designed to prevent another computer-driven market meltdown/rebound and to bolster confidence in the markets. But subsequent high-profile market fiascos – from the flawed Facebook and failed BATS IPOs to the Knight Trading computer glitch – even shook the confidence of market insiders in the ability of the increasingly complex and fragmented markets to self-correct. Two thirds of institutional traders and technologists informally polled at a trading technology conference last fall said they favor overhauling market structure, while one third reported ‘weak or very weak’ confidence in stock market structure, according to industry trade reports.
Despite record-setting market highs, continually shrinking trading volumes and increasingly equity-shy individual investors have added to concerns the public generally has lost confidence in the integrity of the stock market. Now some insiders are pushing for regulators, markets and politicians in the US to move beyond rhetoric and begin serious exploration of changes such as partially rolling back decimalization, imposing a minimum time duration for bids, increasing regulatory transparency of dark pool participants and making all trading activity data publicly available.
Andrew Brooks, head of US equity trading at T Rowe Price, says eroding market confidence is partially due to the public’s belief ‘the SEC is not keeping up with technology, high-frequency trading (HFT) and market manipulation.’ Speaking at the Society of American Business Editors and Writers’ 2013 Annual Conference in April, he cautioned: ‘There are always bad actors, but our regulators are increasingly unable to find them’ as the SEC lacks the tools.
Brooks called on the journalists present to educate the public about the need for structural reforms. He also threw out a challenge to public companies. ‘The issuer side of the equation has been woefully quiet,’ he said. Citing two stocks at the center of the flash crash, he argued that the market’s obligation to provide best execution was not fulfilled on that day: ‘If I were Accenture or Procter & Gamble, I’d like to know why someone kept routing orders to markets that were less and less liquid.’
Brooks, who testified before a congressional committee on computerized trading last fall, described ‘a whole subculture’ of order flow and prioritization that he said ‘is not in the interest of the investing public – we need to talk about that.’
One argument often made by HFT firms defending the current market structure is that the liquidity they provide makes markets more efficient and lowers costs compared with the specialist system that computerized trading replaced. David Lauer, a former quantitative analyst at two HFT firms and now a technology consultant, calls the comparison ridiculous. ‘We should compare it to what an advanced technological system could look like versus what it does look like: extremely complex, fragmented, difficult to navigate,’ he told journalists at the same conference.
Lawrence Leibowitz, COO of NYSE Euronext, believes market structure is a high priority among issuers. ‘Decimalization seemed like a really good idea. But declining spreads had negative unintended consequences on small and mid-cap stocks in particular, with declining liquidity and shrinking research coverage,’ he told the audience at the business writers’ conference. He added that questionable trading activity in these stocks is often driven by institutions playing ‘a cat-and-mouse game trying to figure out where the liquidity is.’
Pointing to a provision of the JOBS Act instructing the SEC to study the impact of decimalization, Leibowitz said the NYSE is on record as favoring a year-long pilot program that would expand tick sizes for 300 to 500 less-liquid stocks. While he is optimistic this particular piece of market structure reform remains a high priority, he wryly predicted any change will occur ‘at the speed of regulation’.
