Pound Flash Crash Had No Single Trigger, BIS Investigation Finds

  • Time of day, stop-losses and expertise of staff played a role
  • Financial institutions didn’t face losses, according to BIS

What's Behind the British Pound's Flash Crash

The Bank for International Settlements found no single smoking gun in its investigation of the pound’s flash crash, instead suggesting factors ranging from the time of day to the lack of expertise of staff as the reasons behind the currency’s sudden plunge.

Sterling tumbled more than 6 percent in the space of two minutes in overnight trading on Oct. 7, with data compiled by Bloomberg showing it touched $1.1841, the lowest level in 31 years. The flash crash in the world’s third most-traded currency pair added to the woes of a beleaguered pound that has fallen 18 percent since the U.K’s June vote to leave the European Union.

The analysis, done in conjunction with the Bank of England, points to a confluence of factors catalyzing the move, rather than to a single clear driver. Among those, the time of day played a significant role in making the market more vulnerable to imbalances in order flow, according to the BIS. The significant demand to sell sterling to hedge options positions and the execution of stop-loss orders as the currency depreciated also had an impact, while the presence of staff with less expertise in the suitability of particular algorithms for the market conditions appeared to have amplified the movement, the report found.

The flash crash wasn’t a “new phenomenon,” the report said. “Rather, it represents an additional data point in what appears to be a series of flash events occurring in a broader range of fast, electronic markets than was previously the case, including those markets whose size and liquidity used to provide some protection against such event.”

The BIS report identified three distinct stages in the flash crash:

  • Stage 1: shortly after midnight U.K. time trading volumes picked up sharply and sterling began to depreciate; pound-dollar bid-offer spreads remained little changed.
  • Stage 2: at 12:07:15 a.m., the CME paused trading for 10 seconds on the futures exchange, in response to the large moves in the preceding two seconds; at this point, bid-offer spreads in the spot market widened significantly; after reaching $1.24, the pound accelerated its fall and market functioning continued to deteriorate; by 12:07:34 a.m., the pound had reached $1.20 and the move had exhausted the resting sterling bids across a variety of electronic trading platforms’ order books.
  • Stage 3: by around 12:20 a.m., prices in both the futures and spot market had settled around 2.2 percent lower against the dollar than their levels immediately prior to the event.

The report found that there were no material losses incurred by systemic financial institutions and that there were few spillovers to other currencies or asset classes. Still, according to the BIS, sudden moves have the potential to undermine confidence in financial markets and hence impact the real economy, meaning policy makers need to develop their understanding of such events.

The pound’s flash crash followed similar events for the South African rand and New Zealand dollar. A December report from the BIS found that declining volumes in the $5.1 trillion-a-day currency market may make it more difficult for traders to hedge, and have coincided with surging volatility and more cases of violent market moves.

“It is vital that we learn the lessons of this flash event and similar episodes in other financial markets, as orderly market functioning underpins market confidence,” BOE Governor Mark Carney said in prepared comments accompanying the report.

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