Mini Flash Crash Bites Some ETFs

August 24, 2015

Did ETF investors just live through another flash crash this morning? That’s the question some advisors are trying to answer after massive selling in early trading hours saw some ETFs flirt with 50-plus-percent losses—all while the S&P 500 registered a 4 percent decline.

These weren’t illiquid, small ETFs either. The iShares Select Dividend (DVY | A-69) traded some 36 percent lower; the Guggenheim S&P 500 Equal Weight (RSP | A-83) hit a 42 percent drop and the iShares Conservative Allocation Fund (AOK) traded roughly 50 percent below its Friday close.

In addition, the iShares S&P Mid-Cap 400 Growth (IJK | A-77), the iShares U.S. Broker-Dealers (IAI | C-76), the PureFunds ISE Cyber Security ETF (HACK | C-26) and the Emerging Markets Internet & Ecommerce Fund (EMQQ | F-20) were also among the ETFs hit the hardest, according to sources.

Source: Bloomberg

Big Discounts To NAV
ETF investors basically sold these funds at massive discounts to their fair net asset value, just to see those security prices bounce back in a matter of minutes. Paul Weisbruch, of Street One Financial, said the problem could have stemmed from pent-up sell stops that hit the market after investors struggled to log in to their online brokerage accounts for about 20 minutes around the market open.

“It's feasible to me, that since the futures were down roughly 5 percent on the open, and there were clear sell imbalances across the board and potentially ‘pent up’ ‘GTC’ sell stops on the books across many brokerage firms, that a cave-in effect may have occurred, resulting in artificially low prints and prices,” Weisbruch said.

But to Kim Arthur, of Main Management, these “bad prints” are not a small issue. On the contrary, they are a reminder of the fragility that still pervades the quickly growing ETF industry even five years after the May 6, 2010, flash crash.

Reasonable Bid/Offer Tolerance Needed
At the heart of the issue is responsibility, he says. Issuers need to be more actively concerned with trade execution on their funds, and market makers have to know when to get out of the market when they can’t provide “realistic bid/ask spreads.” Because at the end of the day, it’s smaller retail investors who can get hurt because they tend to be the ones selling in a panic through market orders.

“I had thought, along with that flash crash in 2010, [regulators] told market makers they had to have some reasonable tolerance within your bid and your offers; otherwise, you cannot be making a market. You have to get out of the way,” Arthur said. “It seems like we saw that again this morning.”

“My question is, why wasn’t bid/ask spread being enforced in a tighter fashion?” Arthur said. “Here’s the ETF industry with $2 trillion now; it keeps getting bigger, but it keeps getting stained with these trading issues. Issuers need to control the trading. You don’t have this problem with mutual funds.”

‘Not An ETF Issue’
In a mutual fund, orders will get credited at NAV at closing. But in an ETF, if an investor sells at a deep discount to NAV, tough luck.

“It’s not an ETF issue; it’s an equity market structure issue around limit up/limit down,” Reggie Browne at Cantor Fitzgerald said of this morning’s issue, pointing out that single stocks such as Ford’s or XL Group’s also faced massive declines.

Chart courtesy of StockCharts.com

Browne is only one widely respected market maker to suggest there was no flash crash to speak of. Trading took place as it should.

What happens next is anyone’s guess. Arthur says there should be an investigation into these bad trades.

But Weisbruch argues that’s unlikely to happen: “As far as whether these prints will be taken down or adjusted, that is hard for me to tell. This volatility is simply unprecedented—at least in recent times—and it will be very hard to bust trades especially since the market has reverted significantly higher to current levels since the steep selloff on the open.”


Contact Cinthia Murphy at [email protected].

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