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Nasdaq Signals – Is Anyone Listening?

Less than year after Hurricane Sandy, a technical issue with Nasdaq brought stock trading to a halt for an unusually long time. It's time to address the need for more robust plans and systems, writes Steven Davenport.

The outage with Nasdaq gave investors reason to pause before the normally volatile month of September. As we await information on a cause for the outage, we review problems with Goldman Sachs’ inadvertent release of options orders and Chinese broker Everbright Securities’ accidental order. The former exposed the firm to hundreds of millions in losses before being cancelled by the exchanges and the latter caused the Chinese market to rise suddenly by 5.6%.

While these may be isolated incidents, Nasdaq has long stood as a symbol of technology success, of bringing the best in American ingenuity to market. Names such as MSFT, AAPL, INTC and GOOG were brought public in a market viewed as a leader in electronic trading. With such an issue arising in a relatively smooth market, are we prepared for the consequences in less favorable conditions?

The technical issue with Nasdaq would have been easier to understand if there were more information about the system which caused the outage and the reason for its failure. In an age where we expect redundant resources, the process came to a halt for an unusually long time.

When hurricane Sandy hit New York and closed markets, it seemed to highlight the fact that operations need to account for unusual natural events. For us to see this type of issue less than a year later, it seems like we are not addressing the need for more robust plans and systems. The other markets kept trading in NYSE-listed securities during the Nasdaq outage but it was with a sense of caution and fear. A lack of clarity during the outage was also troubling. I think the market needs to understand whether this was a self inflicted issue or whether external forces (i.e. hackers) caused the outage. Even recent network outages at large companies, such as Amazon and The New York Times, make us realize that we must remain diligent to prevent forces from derailing the normal function of our economy. Our financial exchanges are a key piece in the functioning of that economy.

No contingency plan can fully anticipate all stresses or scenarios, but the important element is to apply some diligence to the process. As risk manager for high net worth clients, I try to help individuals and families stress test their own financial systems. How comfortable are you with a 10% decline in U.S. equities or a 20% decline in emerging markets? Is there sufficient liquidity to maintain your lifestyle through a market closure? How will higher interest rates impact you over the next few months? We are constantly looking for new methods and tools to help manage client risk. The armed forces use an expression which I think applies, “semper paratus” , which means “always prepared”. We should keep this in mind as we look ahead at the macro environment: escalating violence in the Middle East, Fed tapering of bond purchases, the German elections, and the U.S. debt ceiling and budget approval for 2014 fiscal year

There are no perfect systems or processes but the solution starts with an honest evaluation of the risks and the effort to resolve the issues within your control. With the VIX (S&P 500 volatility) at below average levels, it is better considered now than during a period of even more heightened uncertainty. The systems we depend on need to evolve and improve to deal with a more complex environment. These incidents should be declining and not expanding.

The views expressed herein are those of the author and do not necessarily reflect the view of the authors employer or other firm associates.

Steve is responsible for developing risk-managed investment strategies for high-net-worth clients. He has a strong background in quantitative investment analysis, and a sophisticated approach to asset allocation and the use of derivatives. In particular, he has managed a call ... View Full Bio
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