iShares: Market Structure Behind Flash Crash

August 09, 2010

What caused the ‘flash crash?’ Market structure, stupid.

BlackRock, Inc., owner of the iShares family of ETFs and the world’s largest money manager, today released results of its research into the May 6 “flash crash.” The bottom line: Market structure was largely to blame for the biggest intraday drop in Dow Jones history.

Specifically, overreliance on computer systems and high-frequency trading were the principal culprits behind the extreme volatility that day, according to the financial advisers interviewed in the iShares-commissioned study.

Advisers also pointed to, among other various causes, the use of stop-loss orders and the support—or lack thereof—of market makers, as well as uncertainty surrounding rules that govern the routing of market orders among the various
U.S.
exchanges.

BlackRock’s findings are largely consistent with the SEC’s own investigation of the flash crash. The SEC found that high-speed electronic trading and the use of “stub quotes”—the minimum and maximum prices market makers are required to publish to legally maintain a market—set the stage for the events of May 6.

In the immediate aftermath of the flash crash, the Securities and Exchange Commission, in conjunction with the New York Stock Exchange and the Financial Industry Regulatory Authority, agreed to cancel trades in any security that were executed 60 percent or more away from the last good sale. ETFs accounted for roughly 70 percent of the canceled trades.

BlackRock said fully one-quarter of the advisers interviewed reported that the steep drop in
U.S.
markets between 2:30 and 3:00 p.m. ET on the afternoon of May 6 triggered stop-loss orders in their accounts, resulting in the sale of some securities at steeply reduced prices.

“We commissioned the ‘Flash Crash’ Perceptions Study to learn from financial advisors, one of the largest groups of ETF users, what they think about the market event that affected ETFs as a category,” said Noel Archard, an executive at BlackRock.

 

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