As the one year anniversary of the May 6 "flash crash" approaches, industry executives said weak investor confidence in equities remains the biggest challenge facing the market and the trading industry.
Despite greater regulatory and industry emphasis on market structure, investor inflows are down compared to before the market swoon. That’s what executives said at a panel sponsored by the electronic broker Liquidnet at its New York headquarters on Wednesday.
The panel, "The Flash Crash: A Year Later," pondered if equities are now safer since safeguards have been put into place.
Since the Jan. 1, the Dow Jones Industrial Average has gained 10.25 percent and the S&P 500 has increased 8.25 percent.
Panelists said that more work needs to be done to avoid another market disruption. That’s despite fixes such as single-stock circuit breakers, adoption of erroneous trade policies, the banning of "stub quotes" and new proposals such as "limit up/limit down" and "trade-at."
Speakers noted how investors felt about the "flash crash," pointing to the fact that cash left equities and moved into other asset classes, like bonds and commodities for most of 2010. This led to a decline in equities trading volumes and commissions—a bad development for all in the industry.
The handwriting was on the wall—either do something to instill confidence or continue to see the equities markets lose market share.
According to the latest mutual fund data from the Investment Company Institute, for 2010 U.S. stock funds posted a net cash outflow of $95.8 billion, compared to outflows of $39.5 billion in 2009 and $151 billion in 2008.
However, early data for 2011 look promising as $20.7 billion has come into the equity markets year-to-date.
Still, the lack of investor confidence is the central issue facing the marketplace, and renewing it is the key to getting more investors involved again, according to Eric Noll, executive vice president in charge of transaction services at Nasdaq OMX
"I think it’s important for us, as exchange operators," he said, "to make sure we are explaining how the markets work, how transparent they are in the way they work, in the rules in which they work, how decisions are made and why certain decisions are made." These explanations, he added, are critical to restoring confidence. And Noll thinks the exchanges have a role to play in that effort.
Noll noted that the industry has to convince investors of the equity market’s soundness. "We have to say to people again, ‘this is how we do this and how we operate. This is why we do the things we do’ and continue to explain why that is."
And while exchanges like Nasdaq have a vested interest in investor confidence, regulators have a role to play too, said Richard Repetto, principal in equity research at brokerage Sandler O’Neill. He said the flash crash showed that market regulation had lagged the developments in market structure and that scared investors.
"I don’t think regulation up to the May 6 flash crash had moved as far forward as the advancements in trading had," Repetto said. "After the flash crash, it’s in everybody’s interest to make sure regulation keeps pace with the developments in trading technology and market structure."
According to the official joint Securities and Exchange Commission and Commodities Futures Trading Commission report, the May 6, 2010 flash crash was triggered by a 75,000-contract, algorithmic trade in E-Mini contracts by an institution.
Following that trade at 2:32 p.m., against a backdrop of unusually high volatility and thinning liquidity, a money manager began selling the E-Mini contracts, valued at approximately $4.1 billion, as a hedge to an existing equity position. The algorithm executed its sales in about 20 minutes. During the height of the flash crash, the Dow Jones Industrial Average dropped almost 1,000 points. The market then recovered, ending the day down 342 points.
"There’s a need here for global coordination," said Vlad Khandros, who heads market structure and government relations at block trading venue Liquidnet. He added that future regulation should be done on a global basis. He cited the growing number of inter-listed securities in the U.S. and in Canada.
"There are a lot of regulatory views out there. Without some type of coordination between the regulators, it could lead to artificial [regulatory] arbitrage," he said.
Another factor behind the "flash crash" is the increased level of off-board trading in the market, other panelists said. Larry Tabb, chief executive of the Tabb Group, a market consultant, said that with an increasing amount of trading volume occurring in dark pools or being internalized, it is no wonder investors are worried and lack confidence.
"I’m not sure people will have confidence in a market when one-third of the volume is being done in the dark and internalized," he said. "I can’t see the SEC leaving this issue alone. You can’t not look at this issue."
