The World Federation of Exchanges (“The WFE”), the global industry group for exchanges and CCPs, published a research paper titled ‘Circuit breakers and other market safeguards,’ as part of the industry’s work on systemic resilience and the structures that support market integrity.
This paper, the first of a two-part series, examines and analyses the kind of circuit breakers and other safeguards that are most prevalent among exchanges today and how they were used during the recent COVID-19 related events. The analysis focuses on the equity markets, covering both cash equities and equity derivatives, and reflects exchanges’ views on the topic over the period from June to November 2020, when the survey was conducted.
Exchanges employ a variety of methods, including market-wide circuit breakers, trading halts on individual instruments, and price limits, to prevent sharp price movements that could affect fair and orderly trading and the integrity of their markets. In particular, circuit breakers are mechanisms that temporarily halt continuous trading or delay an auction as and when excessive volatility disrupts the price discovery function of exchanges.
Circuit breakers re-entered the policy debate in spring 2020 because of the heightened volatility experienced by financial markets in March 2020, at the first peak of the COVID-19 pandemic in Europe, which triggered trading halts in numerous markets worldwide. Higher volatility is expected to remain a feature of 2021.
- Exchanges use various tools to safeguard the orderly functioning of markets and to maintain a healthy price discovery process. Although not the only ones, the most prevalent of these safeguards are circuit breakers and price limits, which can be used jointly.
- Circuit breakers are in place in a large majority of exchanges surveyed (86%), although there is some degree of variation in their design or in their calibration, reflecting differences in both the markets themselves and in their respective regulatory regimes.
- Circuit breakers are more prevalent in cash than in derivatives markets (84% vs 67%).
- A large proportion of respondents (67%) confirmed circuit breakers were triggered during March 2020. As a result of these events, some exchanges (30%) have reviewed or are expecting to review their calibration.
- None of the respondents saw coordination of circuit breakers across venues or jurisdictions as a priority.
- The correct calibration of circuit breakers was ranked by participants as the most relevant practical question relating to market safeguards, followed by an assessment of their effectiveness.
Nandini Sukumar, Chief Executive Officer of the WFE said: ‘The events of the last year have led to a renewed interest in the usefulness and benefits of circuit breakers and in their design. Exchanges and other market infrastructures are committed to ensuring the resilience of markets and believe that analysis, data and innovation lead to optimal mechanisms through which volatility can be managed. This paper is designed to be both educational and a base for further thought.’’
Pedro Gurrola-Perez, Head of Research at the WFE said: ‘In line with WFE’s mandate of educating stakeholders on how exchanges and CCPs serve the economy, this paper contributes to the wider understanding of the tools that exchanges use as safeguards to maintain orderly markets and of the design choices involved.”