The chief executives of the two biggest exchange groups are reconciled to implementing a new short-sale rule, even though neither considers it necessary.
Duncan Niederauer, CEO of NYSE Euronext, and Robert Greifeld, president and CEO of Nasdaq OMX Group, both suggested earlier this week that a new rule may be inevitable even though it might not be warranted. The two men spoke at the Securities Industry and Financial Markets Association annual conference in New York on Tuesday.
Niederauer told the crowd that “we may just have to take one for the team.” In his view, an uptick rule or price test or some other mechanism to curb short sales may simply be necessary in the face of public and Congressional concerns about short selling. Many trading executives are not convinced that a short-sale trading rule would be effective.
Niederauer was clear about his view on the uptick debate. “I don’t have a dog in this hunt,” he told SIFMA attendees. “Do I think that restoring the uptick will change how the markets work? Not really. Can I give you a 500-page economic treatise on what it’s going to do? Nope. But I don’t think anyone can give you one about all the negative things it’s going to do either.”
Robert Greifeld, president and CEO of Nasdaq OMX Group, agreed with Niederauer when he took the podium. “We [at Nasdaq] don’t have any religion when it comes to circuit breakers or the uptick,” he said. “Our religion is to make sure we don’t have to do a lot of work and that it doesn’t affect the normal functioning of the market.”
Both men acknowledged that short selling is a topic that rouses passion in the marketplace. “I’ve gotten a lot of mail that isn’t fan mail about us coming out pretty publicly and universally in support of thinking about a price test or uptick test and reinstating it,” Niederauer said. But, he added, “our issuers are of the opinion that’s a good idea.”
Niederauer and Greifeld said they’ve spoken with one another as well as with other exchange executives and regulators about an uptick rule, various types of price-based tests and a circuit breaker. However, no consensus has emerged about what should be done, if anything.
All would be efforts to put brakes on short selling without jeopardizing market efficiency and liquidity. The uptick rule and price-based tests restrict short sales in the market at the transaction level.
A circuit breaker, in contrast, would serve as a fault line between what’s considered normal market conditions and periods of extraordinary price movement that would dictate different rules around short selling. For instance, a circuit breaker could specify that no short selling would take place the next day if the Dow Jones Industrial Average dropped 10 percent in a single trading session. It could also be triggered by big percentage declines in individual stocks.
The decision about a possible new rule to curtail short selling is in the SEC’s hands. But the SEC hasn’t made up its mind about what to do. “The Commission staff are analyzing various suggestions for price tests to protect investors and preserve market integrity, but as yet have drawn no conclusions,” John Nester, a spokesperson for the SEC, told Traders Magazine this morning.
The SEC revoked the uptick rule on the New York Stock Exchange and Nasdaq’s bid test in July 2007. That decision followed a lengthy study that analyzed several years’ worth of data and concluded that the existing price tests did not prevent stocks from declining and did not provide a useful market benefit. However, in the wake of recent market declines and volatility, many investors and issuers have demanded some solution intended to put brakes on sudden downdrifts in share price.
The issue for the trading industry is that instituting an uptick rule or some version of a price test in an electronic environment where prices are moving rapidly may render the effort useless. Within one second, for instance, a declining stock may have multiple upticks.
“Implementing an uptick rule is complex” when the market is trading in milliseconds, Lawrence Leibowitz, head of U.S. execution and global technology at NYSE Euronext, said last week at a Financial Times conference in New York on electronic markets. He said it wasn’t clear what would constitute the metric for an uptick. “Is a single tick an uptick?” he asked.
An uptick requirement or price-based rules could also slow down trading at market centers. David Weisberger, head of global electronic market access at Citi, pointed out to Traders Magazine that most matching engines of exchanges and ECNs don’t capture trades on other markets before executing, and would need to do so to employ a tick test. If they had to consume this additional data and validate each individual match involving a short seller against other markets, he said, the resulting processing requirements “could cause the engines to slow significantly” during high-volume times.
In addition, Weisberger said, if that validation used the securities information processor, or SIP, to check the ticks on other venues, there could be a half-second delay from the actual sequence of events. “And it could be a full second in spiky times,” he noted.
The circuit breaker idea has fared somewhat better as a potential solution because it’s considered easier to implement for exchanges and brokers. However, that, too, has its weaknesses. Stocks that decline for fundamental reasons could get caught in a circuit breaker net. “I don’t, personally, want me or Bob [Greifeld] to be the judge and the jury” when it comes to deciding when a stock’s decline triggers a short-selling halt, Niederauer said.
To be effective, a circuit breaker would also have to be immediate. “It would be more effective if it were intraday,” Niederauer observed. But the New York has elsewhere said that an intraday circuit breaker could take months to implement.
Citi’s Weisberger agreed that a circuit breaker should kick in immediately. He suggested a circuit-breaker-based solution that might be easier for the industry to manage: allow short sellers to only add liquidity when the circuit breaker is in effect. Once triggered, he said, short sellers would be required to submit orders tagged “add only.” That means their orders would not hit bids but would instead provide liquidity.
The benefit of this, Weisberger said, is that the circuit breaker could operate intraday and with minimal new systems work by exchanges and brokers. “All exchanges already take add-only orders, and all brokers understand the difference between adding liquidity and taking it,” he said. “As a result, brokers could develop surveillance processes and exchanges could built edits far easier than requiring changes to the core matching engines.”
