Liquidity replenishment points, the New York Stock Exchange’s system of curbs to slow trading when prices move rapidly, will be eliminated following instructions from securities regulators, NYSE Euronext (NYX) said.
The LRPs will begin to be withdrawn next week when new circuit breakers for individual stocks and the broader market go into effect across all equity venues, the exchange said in a proposal submitted to the Securities and Exchange Commission. NYSE objected to ending LRPs, which operate only on its market, saying they benefited investors, according to the filing.
Regulators have been fine-tuning systems for pausing trading since the so-called flash crash of May 2010 briefly erased $862 billion from equity markets. Two initiatives for curtailing volatility will be implemented April 8 for one-year pilots: a program known as limit-up/limit-down for individual shares and a refurbished system for halting all exchange-listed equity trading in U.S. securities and futures markets during periods of extreme volatility.
“Market participants want competition in many areas but post-flash crash it became clear the industry didn’t want multiple means of addressing volatility through pauses,” Jamie Selway, head of electronic brokerage and sales at Investment Technology Group Inc., said in a phone interview. “NYSE found a technological way to do what the trading floor did, which was to slow things down when they got volatile, but as a policy matter people didn’t want exchanges to have idiosyncratic mechanisms.”
U.S. stock exchanges and the Financial Industry Regulatory Authority, which oversees almost 4,300 brokers, introduced curbs for individual stocks after the flash crash to halt shares when they rise or fall at least 10 percent in five minutes. The limit-up/limit-down system, which will replace that program, is likely to cause fewer halts, according to the SEC.
More than two dozen companies listed on exchanges owned by NYSE Euronext, Nasdaq OMX Group Inc. (NDAQ) and Bats Global Markets Inc. will switch to the limit-up/limit-down curbs on April 8. More will be added each week through mid-May until all Standard & Poor’s 500 Index and Russell 1000 Index companies and several hundred exchange-traded products are included.
The curbs will operate from 9:45 a.m. to 3:30 p.m. New York time. Other securities will be added in August to the program, which will then run the full day from 9:30 a.m. until 4 p.m.
“The initiatives we approved are the product of a significant effort to devise a sophisticated, yet workable and effective, way to protect our markets from excessive volatility,” former SEC Chairman Mary Schapiro said last June in a statement about the new volatility-limiting programs. “In today’s complex electronic markets, we need an automated and appropriately calibrated way to pause or limit trading if prices move too far too fast.”
Under the limit-up/limit-down system, trades won’t be allowed to take place more than a specified percentage above or below a stock’s recent average price. If no trades occur within the band for more than 15 seconds, a five-minute halt will ensue, according to the SEC.
The plan will also give the market that lists a security the discretion to declare a trading pause when a stock has “deviated from its normal trading characteristics” and the exchange decides that a halt would curtail excessive volatility, the SEC said. This will ensure a company’s shares don’t “remain impaired” indefinitely, it said.
NYSE and NYSE MKT, the exchange operator’s platform for smaller companies, will end their LRPs as the new curbs are introduced for specific stocks.
“Despite the benefits to investors and issuers and our belief that LRPs would add to the limit-up/limit-down protections, the SEC has insisted that we eliminate this valuable functionality,” Richard Adamonis, a spokesman for NYSE Euronext, wrote in an e-mail. “We’re reluctantly complying.”
NYSE may seek to reintroduce LRPs after the initial pilot “if doing so will be beneficial to investors, issuers and our market,” he said. The exchange will analyze data from before and during the limit-up/limit-down program to see whether its own curbs should be tried again, he said.
NYSE criticized the SEC for ending the program without an “impact analysis” study, according to the filing. While the regulator has said multiple volatility curbs operating together could create investor confusion, the exchange said it should have been allowed to test whether its LRPs could run smoothly in conjunction with the new programs. The Securities Industry and Financial Markets Association and Deutsche Bank AG told the SEC in letters in 2011 that too many different curbs might impair the effectiveness of single-stock circuit breakers.
“The SEC staff is micromanaging exchange operations without a really thorough analysis,” James Angel, a finance professor at Georgetown University in Washington, said in a phone interview. “On the one hand an individual exchange curb may merely shunt disturbances to the rest of the market, but on the other hand exchanges should have the freedom to design their own trading mechanisms.”
Exchanges and brokers have been testing notifications for the programs over the last month and scenarios in which trading is limited or halted in preparation for April 8.
The commission has said it expected exchanges to eliminate volatility curbs that apply only on their own venues. NYSE Euronext Chief Operating Officer Larry Leibowitz credited the system with preventing stocks his company lists from trading at aberrant prices such as pennies during the flash crash.
NYSE canceled no trades on May 6, 2010, while other exchanges voided more than 20,000 transactions totaling 5.5 million shares, according to a report by the SEC and Commodity Futures Trading Commission published in October 2010. More than 1,000 companies triggered LRPs lasting more than a second between 2:30 p.m. and 3 p.m. on May 6, compared with 20 to 30 on most days, the report said. Some exchange and brokerage executives said NYSE’s actions may have caused liquidity to move to other venues and created confusion in the market.
The SEC also altered the marketwide circuit breakers that halt all trading, created in the aftermath of the October 1987 crash, because they weren’t triggered during the May 2010 rout. The alterations will make the curbs “more meaningful and effective in today’s high-speed electronic securities markets,” the agency said in its approval order last year.
All U.S. securities trading will halt for 15 minutes when the S&P 500 falls 7 percent before 3:25 p.m. The trigger is currently a 10 percent drop in the Dow Jones Industrial Average. The proposal also shortens the length of most halts and modifies the times when the circuit breaker can be triggered. A plunge of 20 percent will cause all trading to stop for the day. The marketwide pause has been triggered only once, on Oct. 27, 1997.
These curbs will go into effect for equity index futures on the Chicago Mercantile Exchange and Chicago Board of Trade on April 7 to ensure that the related markets remain linked, the exchanges told the CFTC in January.
A 20 percent plunge in the last 35 minutes of trading would be “extraordinarily disruptive” and could threaten the market’s infrastructure, CME Group Inc. (CME) said in January. Closing futures trading until 9:30 a.m. New York time the next morning is excessive and activity should be allowed to resume at 6 p.m. the same day, it said.
How curbs for individual securities will work with those that halt all trading is “poorly understood,” CME said. Staggered halts in multiple stocks in the S&P 500 could prevent proper calculations of the index and hurt the willingness of firms to supply liquidity at a time when it’s needed most, the company said.
CME and Sifma urged the SEC to allow marketwide curbs to be triggered if a sufficient number of individual stocks are halted since that may affect the calculation of indexes. The SEC said market participants could submit comments about this issue while the programs are being tested.
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