Disruptions such as last month’s three-hour shutdown by the Nasdaq Stock Market will never be completely preventable and U.S. regulators shouldn’t make perfection their goal, according to a Bloomberg Global Poll.
While U.S. Securities and Exchange Commission Chairman Mary Jo White urged efforts to strengthen markets following the Nasdaq mishap, 35 percent of those surveyed say regulators shouldn’t try to enforce zero-fault tolerance in equity markets, eight percentage points more than those who say they should, according to the global poll of investors, analysts and traders who are Bloomberg subscribers.
“Market participants need to understand, as do the regulators, that nothing is perfect and there will occasionally be problems, but that’s part of the evolution of the capital market,” respondent Kevin Divney, chief investment officer at Beaconcrest Capital Management LLC in Boston, said in a phone interview. “If the regulators put too high a penalty on the market structure, they could impede innovations.”
Nasdaq’s shutdown on Aug. 22 underscored how quickly order in the U.S. stock market can be subverted as requests to buy and sell shares are matched on more than 50 exchanges and alternative venues around the country. The outage, the latest in a series of failures to disrupt increasingly complex markets, prompted the SEC to push exchanges to improve the reliability of their technology.
Speed Limits
In the poll, respondents were divided on whether regulators should slow down the speed of trading, with 43 percent opposing such rules and 42 percent supporting them.
U.S. stock exchanges now quote the reaction time of their systems in microseconds to accommodate the computers at high-frequency and algorithmic trading firms, who have replaced humans in much of the American equity market. Concern over the pace of trading intensified following the May 2010 plunge, known as the flash crash, that erased about $862 billion of value in minutes. Malfunctions at Goldman Sachs Group Inc. in August and Knight Capital Group Inc. 13 months ago heightened concern about the reliability of markets.
One solution might be introducing a small delay in trading, said Donald Selkin of National Securities Corp., a brokerage and investment firm.
Pooling Orders
“Incoming orders — instead of a first-in, first-out situation where the fastest computers would get priority — should instead be batched or bunched together and thus dealt with in random order, thereby insuring greater equality in terms of execution,” he said. “Trading would take place as usual, but with some very small delays in order to ensure a more equitable order of execution.”
The May 2010 crash prompted the SEC to mandate trading curbs meant to prevent losses in any single stock from sparking panic. The curbs transitioned this year to a system known as limit-up/limit-down, which mandates that traders only quote stock prices in designated bands around the current price.
This week, the U.S. Commodity Futures Trading Commission sought comments from the industry on potentially restricting high-speed and algorithmic derivatives trading.
“I fundamentally disagree with anything that impedes the price discovery process,” Simon Batten, the founder and chief executive officer at Ermine Capital Management LP in Stamford, Connecticut, wrote in an e-mail. Ermine invests in equities, currencies and fixed income.
Lehman Collapse
Five years after the failure of Lehman Brothers Holdings Inc., respondents were split on whether U.S. regulators are well prepared to deal with the collapse of a major financial company. Half of the respondents considered regulators “mostly prepared” though some government assistance might be needed. Thirty-five percent said regulators are “mostly unprepared.”
While the amount of capital at the six largest U.S. lenders has almost doubled since 2008, some critics say that’s not enough. They see a system still too leveraged, complicated and interconnected to withstand a panic, and regulators ill-equipped to head one off — the same conditions that led to the last crisis.
“I don’t know that we’ve ever gotten to a conclusion to ‘too big to fail,’ or any of these key concepts,” Tim Hartzell, who helps manage about $425 million as chief investment officer at Sequent Asset Management in Houston, said in a phone interview. “There are so many derivatives contracts that I don’t think the federal government really has a full grasp of what’s out there.”
Lehman’s bankruptcy in September 2008 triggered the worst financial crisis since the Great Depression and forced the U.S. government to bail out the financial industry.
Reg NMS
Nasdaq halted trading in all of its listed stocks on Aug. 22 out of concern a connectivity problem in the price feed, known as securities information processor, would cause uneven dissemination of prices in the market. The disruption snowballed when a software flaw prevented Nasdaq’s backup program from kicking in.
A six-year-old rule known as Reg NMS requires U.S. equity exchanges to route trades to the venue with the best price. As competition intensified, exchanges introduced different order types to lure business. The ensuing complexity poses the biggest challenge to ensuring systems run without failing, Nasdaq OMX Chief Financial Officer Lee Shavel said at a conference on Sept. 10.
“It has created an environment that is inherently difficult to maintain consistency from a technology standpoint,” he said.
‘Impossible Concept’
In the latest attempt to strengthen the fragmented U.S. equity market, White held private talks with exchange executives yesterday to discuss improvements in systems for distributing price data.
“To have all computers operate seamlessly and impeccably in sometimes a volatile environment, I think it’s an impossible concept,” said Bryant Saydah, vice president of institutional equity trading at Juda Group Inc. in Los Angeles.
The survey of 900 Bloomberg customers was conducted Sept. 10 by Selzer & Co., a Des Moines, Iowa-based pollster. The results carry a margin of error of plus or minus 3.3 percentage points.
Source: Bloomberg
