Wednesday, September 15, 2010

Hedge Fund Industry Generally Supports SEC Proposals on Single Stock Circuit Breakers

The US hedge fund industry supports the SEC and self-regulatory organizations’ proposals to adopt uniform market-wide single stock circuit breakers and clearly erroneous trade rules. In a letter to the SEC-CFTC Advisory Committee on Emerging Regulatory Issues, the Managed Funds Association said that the proposed reforms will prevent market disruptions during times of market stress, help restore confidence in the markets and limit harm to investors.

The industry would also support refinements to these rules that would address concerns that most trading halts to-date have been triggered by erroneously reported prices, not actual market activity. Allowing such circumstances to halt trading of stocks is inefficient and creates opportunities for market manipulation. The association also generally supports some other ideas that have been discussed, such as banning stub quotes, implementing market-wide circuit breakers, and expanding the bandwidth for market data to ensure timely quotations, all of which may prevent some market events from cascading into a crisis.

More broadly, the MFA urged the SEC and CFTC to proceed cautiously with reforms and introduce changes that are supported by empirical data. The recent global financial crisis and continuing economic weakness are likely larger contributors to the general market uncertainty than any particular trading rule or practice, reasoned the MFA, and regulatory changes not supported by empirical data and directed at preventing rare market dislocations could further harm investors by decreasing daily market liquidity and raising transaction costs.

The MFA is also concerned that proposals to expand the use of speed bumps, delay trading or set maximum execution speeds would cause greater harm to investors by increasing trading and transaction costs. In the group’s view, limiting trading activities and strategies will only harm everyday liquidity and price continuity with no evidence of efficacy in times of severe stress. Thus, the MFA urged the SEC and CFTC to limit regulatory experimentation.

Moreover, the MFA does not believe that more stringent market maker obligations for firms will prevent a future market break. Indeed, imposing market maker-like obligations on non-market makers may perversely lead to less liquidity in the equity markets. Requiring market participants, to register as market makers could decrease liquidity, emphasized the MFA, since many of them may not be able to commit to meeting market maker obligations, such as broker-dealer capital and margin requirements. As a consequence, such participants would be forced to curtail their trading and investing strategies.

It will be important to build on the SEC’s equity market regulations, including implementation of the Order Handling Rules, Regulation ATS, and Regulation NMS which, in the MFA’s view, have greatly improved the equity markets by removing anti-competitive barriers and promoting fair access to markets and market information. In doing so, the SEC’s regulations have fostered innovations in technology that have revolutionized investing in the equity markets, and promoted greater competition among marketplaces. Most notably, the advancements in technology have empowered investors, both institutional and retail, with more sophisticated and efficient methods to access the markets and execute their investment strategies globally. In the process, these equity market developments have led to greater market liquidity and depth and lower transaction costs.