A 'Flash Crash' Fix
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According to Themis Trading LLC's Sal Arnuk and Joseph Saluzzi the Securities and Exchange Commission will make a number of recommendations shortly to prevent another "Flash Crash" like the one on May 6 that terrified the markets.
The two see the recommendations as nothing more than "temporary Band-Aids" for the markets, and not a permanent solution to the root problems surrounding the "Frankenmarkets."
"Unfortunately, we have a crisis of confidence in our market structure. Until real and perceived inequalities and problems are rectified, that will continue to be the case, and we may continue to see investors flee. Investors want to know that another May 6 cannot happen again," Arnuk wrote. "They want to know that the market is fair and equal for all. And they want to know that the market is structured in a way such that pricing of assets reflects intrinsic values."
The first recommendation that Themis sees coming from the SEC is an alteration to the single stock circuit breaker to include an limit up/down feature. The report suggests that a minimum number of trades occur at the threshold occur to trigger the circuit breaker, to prevent false triggers.
They also see the elimination of stop-loss market orders.
"Many investors that lost money on May 6th did so because they thought they were protecting themselves with stop-loss market orders. As the market melted down, these orders were activated and chased prices down a vicious spiral."
Themis sees the SEC recommending the elimination of stub quotes and allow one-sided quotes.
"When a market order is seeking liquidity and the only liquidity available is a penny-priced stub quote, the market order, by its terms, will execute against the stub quote," SEC Chairman Mary Schapiro said when asked about stub quotes following the flash crash. "In this respect, automated trading systems will follow their coded logic regardless of outcome, while human involvement likely would have prevented these orders from executing at absurd prices."
The stub quotes did not cause the flash crash, but it did expose them and now the SEC will eliminate their use according to Themis.
The report also indicated that the SEC will increase market maker requirements, which will include a minimal time for market makers to quote on the NBBO.
Themis added that it is possible that the SEC will recommend a ban on flash orders and a larger trader reporting system.
While this is what Themis sees the SEC recommending, it is not what they see needing to be done to prevent another Flash Crash.
To fix the problem, Themis looks at mandating fiduciary language for exchanges and brokers, where the same obligations that require money managers to place all of their clients’ needs ahead of their own profitability, would be extended to brokers and exchanges regulated by the SEC.
In addition, Themis sees the need for regulators to institute a broad standard against which it weighs the approval of any new exchange or ATS, in order to avoid market fragmentation.
With more than 90 percent of orders being canceled, Themis suggests that a cancellation fee or minimum orders life to avoid the potential for an overload of data to market centers.
"Orders entered into the marketplace without the intention to trade threaten an orderly market. To control this risk, we would like to see a fee imposed on cancellations."
You can read the entire white paper here.
The two see the recommendations as nothing more than "temporary Band-Aids" for the markets, and not a permanent solution to the root problems surrounding the "Frankenmarkets."
"Unfortunately, we have a crisis of confidence in our market structure. Until real and perceived inequalities and problems are rectified, that will continue to be the case, and we may continue to see investors flee. Investors want to know that another May 6 cannot happen again," Arnuk wrote. "They want to know that the market is fair and equal for all. And they want to know that the market is structured in a way such that pricing of assets reflects intrinsic values."
The first recommendation that Themis sees coming from the SEC is an alteration to the single stock circuit breaker to include an limit up/down feature. The report suggests that a minimum number of trades occur at the threshold occur to trigger the circuit breaker, to prevent false triggers.
They also see the elimination of stop-loss market orders.
"Many investors that lost money on May 6th did so because they thought they were protecting themselves with stop-loss market orders. As the market melted down, these orders were activated and chased prices down a vicious spiral."
Themis sees the SEC recommending the elimination of stub quotes and allow one-sided quotes.
"When a market order is seeking liquidity and the only liquidity available is a penny-priced stub quote, the market order, by its terms, will execute against the stub quote," SEC Chairman Mary Schapiro said when asked about stub quotes following the flash crash. "In this respect, automated trading systems will follow their coded logic regardless of outcome, while human involvement likely would have prevented these orders from executing at absurd prices."
The stub quotes did not cause the flash crash, but it did expose them and now the SEC will eliminate their use according to Themis.
The report also indicated that the SEC will increase market maker requirements, which will include a minimal time for market makers to quote on the NBBO.
Themis added that it is possible that the SEC will recommend a ban on flash orders and a larger trader reporting system.
While this is what Themis sees the SEC recommending, it is not what they see needing to be done to prevent another Flash Crash.
To fix the problem, Themis looks at mandating fiduciary language for exchanges and brokers, where the same obligations that require money managers to place all of their clients’ needs ahead of their own profitability, would be extended to brokers and exchanges regulated by the SEC.
In addition, Themis sees the need for regulators to institute a broad standard against which it weighs the approval of any new exchange or ATS, in order to avoid market fragmentation.
With more than 90 percent of orders being canceled, Themis suggests that a cancellation fee or minimum orders life to avoid the potential for an overload of data to market centers.
"Orders entered into the marketplace without the intention to trade threaten an orderly market. To control this risk, we would like to see a fee imposed on cancellations."
You can read the entire white paper here.
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