Market Makers At Center Of Flash Crash Probe

February 18, 2011


Certainty Needed On 'Broken Trades'


Greater certainty as to which trades will be broken in the wake of aberrant price movements was among the first recommendations the joint committee put forward in its report. Currently, the decision to cancel a trade lies within the discretion of top exchange management and federal regulators.

In the wake of the flash crash, for instance, the major securities exchanges—along with the SEC and FINRA, the financial industry's self-regulatory organization—settled on a formula for canceling so-called broken trades. They determined that any security whose share price moved 60 percent or more between 2:40 and 3:00 p.m. on May 6 was subject to the ad-hoc rule.

"In this new trading environment, market structures and regulation have to be more forward looking, with rules and regulations designed on an ex ante basis rather than an ex post basis," the joint committee said in the report.

Tapping The Brakes Using Price Collars

Instead of stomping on the brakes using hard-and-fast trading pauses based on the departure from the last good price for a security, the joint committee recommended implementing a "limit up/limit down" process that would allow trading to continue within a range of prices.

Indeed, the joint committee views the hard-stop rules in the SEC's pilot program as having a number of drawbacks.

"Specifically, their five minute duration completely restricts trading in a security even if contra-side liquidity has returned to the market."

Given the dramatic changes in the speed of the markets due to high-frequency trading, the joint committee also recommended reducing the length of circuit breaker pauses to 10 minutes and allowing them to be triggered as late as 3:30 p.m. Eastern time.



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