Automated trading systems developed by exchanges underwent their first real test on March 5 as the Trading Phase for operating Reg NMS-compliant trading systems took effect. The basic requirement imposed on exchanges and ECNs by Reg NMS is the ability to automatically route orders to the venue displaying the best price.
"A market's rollout of new trading systems inevitably presents challenges for the market and its participants," said Erik Sirri, director of the SEC's Division of Market Regulation, in a statement issued March 2.
The SEC will be closely monitoring the equity markets to see if any systems or trading problems arise, which is comforting given that on Feb. 27 the U.S. equity markets experienced a decline of 416.02 points — the largest decline since Sept. 11, 2001 — less than a week before Reg NMS took effect. In fact, in his statement, Sirri suggested that the SEC is bracing for the possibility of more problems. "The exceptional trading volume and price volatility of the equity markets over the last few days raise the potential of even greater challenges during the Trading Phase," he said.
While the market decline on Feb. 27 primarily was a reaction to a sell-off in Chinese stocks and is viewed by many on the Street as a long-overdue correction in U.S. stocks, the difficulty in handling the heavy volumes (2.42 billion shares changed hands at the NYSE) raised concerns over the ability of the market infrastructure to withstand surges in automated trading volumes. According to reports, the SEC is looking into what caused the market decline and what role, if any, computer glitches at the NYSE and Dow Jones contributed to the slide.
Among its concerns, the SEC is examining whether the Big Board switched over to electronic trading too quickly and whether the exchange reduced the size of its floor operations too soon. Over the past six months, the NYSE has closed some of its floor operations, resulting in fewer floor traders. In addition, major brokers have been slashing their floor staffs as they commit more resources to upstairs electronic trading.
Even Congress is getting into the act, questioning the NYSE and contacting Dow Jones about the computer glitch in its market data system that caused it to fall behind in calculating the Dow Jones Industrial Average. When Dow Jones switched over to a backup market data system, the market appeared to plummet 200 points instantly. Dow Jones has commented that the market was already down considerably leading into the 70-minute delay (from 1:50 p.m. until 3 p.m.) before it readjusted the index, and therefore the recalculation did not cause the market upheaval. But it could have triggered algorithmic trading strategies that in turn generated a heavy volume of buy and sell orders.
Perhaps we should really be most concerned about the legacy systems that bring orders into the exchanges' electronic matching engines and the capacity of the market data systems. For example, while the NYSE's Hybrid Market was working fine, the Designated Order Turnaround system (known as DOT) had problems feeding orders into Hybrid, according to published reports. Similarly, Dow Jones said the problem it had was in the market data system feeding its calculation engine.
Despite these red flags, the SEC did not postpone Reg NMS a third time. Yet on March 1, the NYSE filed a request asking for relief from parts of Reg NMS. The NYSE requested a one-month delay (until April 5) on the best-execution requirement that it route orders to certain ECNs and the International Stock Exchange that display their quotes on the NASD's Alternative Display Facility.
Still, in the end, the industry is moving forward with the inevitable transition to a more-electronic marketplace, and the SEC is watching as market participants learn the nuts and bolts of the new trading rules.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio