Tuesday, May 18, 2010
US SEC proposes new trading rules
US stock exchanges would briefly halt trading of some stocks that have big prices swings under new trading rules proposed on Tuesday that are aimed at avoiding market plunges like the one that stunned Wall Street earlier this month.Regulators say it makes sense to reach for remedies now, even though they have yet to determine the exact cause of the May 6 market dive.The rules would take effect in mid-June under a six-month pilot program agreed to by major US exchanges and the Securities and Exchange Commission. The SEC announced them Tuesday and put them forward for public comment.Under the plan, trading of any Standard & Poor's 500 stock that rises or falls 10 per cent or more within a five-minute span would be halted for five minutes. These rules, known as "circuit breakers," would be applied if the price swing occurs between 9:45 a.m. and 3:35 p.m. Eastern time. That's almost the entire trading day.In the so-called "flash crash" on May 6, about 30 stocks listed in the S&P 500 index fell at least 10 per cent within five minutes.Importantly, the new circuit breakers would apply to all US exchanges. Most of the 50 or so US exchanges regulate themselves and design their own tools for slowing or halting trading.During the May 6 plunge, the New York Stock Exchange slowed trading according to its rules but the orders that couldn't be executed migrated in a torrent to electronic exchanges, industry officials said.The SEC and the Commodity Futures Trading Commission, in a report by their staffs, said the agencies' investigation of the epic dive — in which the Dow Jones industrials lost nearly 1,000 points in less than a half-hour — is still in a preliminary stage."The decline and rebound of prices in major market indexes and individual securities on May 6 was unprecedented in its speed and scope," said the joint report released Tuesday evening. "The whipsawing prices resulted in investors selling at losses during the decline and undermined confidence in the markets."Only a preliminary picture has started to emerge, the report said. Investigators are focusing on, among other things, a possible link between the steep decline in prices of stock indexes, and "simultaneous and subsequent" waves of selling in individual stocks.Also being looked at is a "severe mismatch" of liquidity in the market that may have been worsened by the withdrawal of electronic traders and the use of so-called "stop-loss" market orders, the report said. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level.SEC Chairman Mary Schapiro told a gathering of financial analysts Tuesday there are issues "we think can be remediated quickly even before we understand necessarily what the exact cause of the crash was."The SEC would vote on formally approving the rules sometime after a 10-day comment period, unusually short for the agency's rule-making and indicating the urgency of the issue. The changes are intended to prevent a recurrence of the plunge that briefly wiped out more than $1 trillion in the market value of stocks."We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges," Schapiro said in a statement. "As such, I believe it is important that all the exchanges quickly reached consensus on a set of uniform circuit breakers that would be triggered when needed."The markets can use the six-month pilot period, which would end on Dec. 10, to make needed adjustments based on how the new rules work, and the scope of the rules could be expanded to stocks beyond the S&P 500 "as soon as practicable," the SEC said. That could include exchange-traded funds, increasingly popular investments that often track a market index such as the S&P 500 and can be traded throughout the day, unlike mutual funds.ETFs as a group were affected by the plunge more than any other category of securities, according to the report.Schapiro has asked the SEC staff to consider during the pilot period ways to address the risks of "stop-loss" and other market orders, and whether so-called "stub quotes" should be curbed or banned. Market makers use stub quotes as placeholders and they are often far above or below actual stock values. But the report said their presence at the top and bottom of order books on May 6 "may have led to a very large number of broken trades."The pilot period will give all market participants, including the SEC, the exchanges and brokerage firms, an opportunity to study the impact of the new rules and fine-tune them, Wall Street's biggest trade group, the Securities Industry and Financial Markets Association, said in a statement.But it may take another market meltdown before anyone knows if the new system of circuit breakers will work, independent market analyst Edward Yardeni noted."The only way we'll find out is if we have another plunge," Yardeni said. "If they kick in and stabilize the situation, then fine. If not, it's back to the drawing board."The SEC already has rules requiring market-wide halts in trading if the Dow falls 10 per cent, 20 per cent or 30 per cent. None of them were triggered on May 6, but it's possible that those rules, also known as circuit breakers, will be re-examined in light of the plunge.The plunge highlighted the growing complexity and splintered diversity of the fast-evolving securities market. Sleek electronic trading platforms compete with the traditional exchanges and powerful computers give traders a split-second edge in buying or selling stocks. The risk looms that electronic errors at high speeds could ripple through markets and disrupt them.Regulators say new rules could help level the playing field for market players and bring order to a patchwork of regulations that are about a decade old.The May 6 freefall also underscored the growing importance of trading in index futures, which allow investors to trade based on expectations whether a group of stocks will rise or fall, rather than simply trading the underlying stocks.While it is too soon to know whether the proposed new rules "will prove sufficient to protect investors and to shelter our markets from sudden, drastic technology-driven swings in our markets, they are an important first step," said Rep. Paul Kanjorski, D-Pa., chairman of the House Financial Services subcommittee that oversees the SEC.