The industry’s market centers moved closer yesterday to standardizing their policies covering clearly erroneous trades but have not yet settled all their differences.
A working group of exchanges and ECNs has held meetings in the last few weeks to try to formulate a single set of rules and procedures governing erroneous trades that can be deployed by each market center. The last meeting was yesterday.
“We’ve resolved some of this,” one market center executive said, “but there are still some outstanding issues.”
The group is under pressure from brokers after a disastrous couple of days in September, when tens of thousands of trades had to be busted. The problems occurred after the Securities and Exchange Commission temporarily banned short sales in 799 financial stocks. A resultant lack of liquidity, high levels of volatility and sub-second trading on electronic venues caused thousands of trades to take place at incorrect prices.
As it stands now, the exchanges and ECNs all treat clearly erroneous trades differently. This frustrates broker-dealers who want all market centers to adopt similar policies and procedures.
The new policy that is emerging is being built around mathematical parameters that are expected to make it easy for brokers and trading venues alike to determine which trades are considered to be clearly erroneous. That is lacking today at many marketplaces. That is expected to eliminate time-consuming dithering over bad trades.
To that end, the emerging policy is centered around three main points. The first point, adopting Nasdaq’s 10-5-3 criteria, has unanimous agreement.
Nasdaq will bust or adjust trades if the transaction price falls too far outside the NBBO. For executions over $1.75, and up to $25, Nasdaq will bust or adjust if that trade price is 10 percent away from the NBBO. For executions over $25, but less than $50, Nasdaq will bust or adjust if that trade price is 5 percent away from the NBBO. For executions over $50, Nasdaq will only bust or adjust if the trade price is 3 percent away from the NBBO.
The final policy may not adopt the NBBO as the exclusive reference price. The last sale, a volume-weighted average price or some other reference price may be utilized. The individual exchange would have the final say as to which reference price it wants to apply to a particular bad trade.
The second point has near unanimous agreement. That is the final policy will take into account volatile market conditions by relaxing the above-mentioned parameters. One idea is to increase the above-mentioned percentages if the S&P 500 Index opens significantly higher or lower than the previous day’s close.
For example, if the S&P 500 opens 3 percent higher or lower, the above-mentioned percentages would double. If the index opens 6 percent higher or lower, the above-mentioned percentages would triple.
The sticking point here is the dissemination of the S&P 500 information. Some exchanges prefer a central clearing house notify the brokers. Other participants prefer it be done by the individual exchanges.
The third point is the most contentious, with participants split 50-50. The final policy may take a different tack when it comes to brokers who do not contact an exchange in a timely manner to report an erroneous trade. Now, under the rules of some exchanges, brokers must report the bad trade within 30 minutes. If they are even a minute late, the trade stands.
Under the emerging policy, these rules are relaxed but the broker might still be penalized. If the broker reports after 30 minutes, the bar for declaring a trade “erroneous” would be higher. The exchanges might decide that a trade would have had to have occurred a relatively large percentage away from the reference price in order to be considered erroneous. The amount away could be a flat 30 percent.
Several of the participants suggested that all busts should be handled automatically, eliminating the need for the broker to even contact the exchange. That idea was scotched, however, as one exchange refuses to automate its busts.
For their part, brokers are pleased with the efforts of the working group and are optimistic that a uniform policy will produce fairness and operational efficiencies and lead to happier clients.
“We believe that if all markets are subject to a similar, if not exactly the same, policy, and are working in the spirit of cooperation, then all investors will be treated fairly because each would be subject to the same rule-set,” said Joe Cangemi, a managing director at BNY ConvergEx and a board member of the Security Traders Association.
Once agreement is reached, the exchanges will have to make rule filings with the Securities and Exchange Commission before any changes can go into effect. The SEC is said to be waiting impatiently for the filings.
