Wednesday, October 03, 2012

SEC Chair Schapiro Speaks on Market Infrastructure

Noting that the stability of the securities markets is tied to the technological infrastructure of those markets, SEC Chair Mary Schapiro said that the SEC must focus on two basic concerns that are highly interrelated: 1) market structure, such as multiple execution venues, the presence of high frequency trading, dark pools, and the like; and 2) market infrastructure, as in the technology that undergirds trading activity.

In remarks at the SEC Market Technology Roundtable, she noted that the SEC has in place single-stock circuit breakers to prevent stocks from falling too far and too fast. The Commission has also approved a more advanced limit up/limit down mechanism to limit excessive volatility.  The SEC also has imposed a ban on stub-quotes and adopted rules clearly defining when a trade can be broken so as to help avoid circumstances that can lead to disorderly trading. 

SEC rules ban naked access and require rigorous pre-trade risk controls designed to help mitigate disruptive trading at the source. Other regulations require large traders, many of whom use high frequency trading strategies, to identify themselves so that the SEC can better monitor and analyze their trades, said Chairman Schapiro, a process that other regulators overseas are beginning to emulate. Additionally, and perhaps most importantly, the SEC requires SROs to develop plans for the first ever consolidated audit trail, which will allow regulators to surveil and reconstruct trading across platforms. 

But, added Chairman Schapiro, there are issues around market structure and the conduct of market participants that the SEC should further examine, including the high volume of cancellations, a proliferation of order types, transparency, high frequency trading generally, potentially manipulative trading strategies, and data latencies for public investors. She emphasized that these issues still require attention and that the SEC is committed to addressing them.

Market infrastructure is essential to any holistic approach to improving how the financial markets operate, said the Chair, noting the IPO of BATS on its own exchange, and the IPO of Facebook on the NASDAQ exchange.  Though there are many views regarding the fragmented nature of simultaneous trading across multiple venues, she believes that these IPO events evidence a very different set of concerns.  Both events involved one of the few single-exchange processes that remain in an otherwise fragmented market,  namely, building a single order book and crossing trades at a single price to open trading for a new public company.

In the case of BATS, it was a flaw in new software code designed to conduct a corporate IPO auction.  That mistake caused the matching engine for tickers in a certain range to enter into an infinite loop, making these tickers, which included the symbol for BATS itself, inaccessible on BATS. 

In the case of NASDAQ, the IPO software was designed to accept cancellations submitted while the final IPO price is being calculated.  Cancellations received during this time changed the order book.  By design, the system recalculated the final IPO price to factor in the new state of the book.  But again, changes were received before the system could print the opening trade, which resulted in additional re-calculations. This condition persisted, resulting in further delay of the opening print. These single-exchange problems are not a result of complexities or fragmented markets, she concluded, but rather a result of more basic technology 101 issues.

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