Hal Weitzman of the Financial Times highlights a purported Need for consistent market structure to avoid ‘flash crash’:
Gary Katz, head of the International Securities Exchange, owned by Deutsche Boerse, dismissed the suggestion that US regulators should focus on creating incentives for market-makers.
“When the market begins to fall like that, there are no incentives big enough to persuade market-makers to catch a falling knife,” Mr Katz said.
Tom Whittman, president of Nasdaq OMX, which operates one of the biggest US options-trading platforms, agreed. “Market-makers wouldn’t have stayed in the market on May 6,” he said. “They’d rather pull out and pay a fine.”
Ed Boyle, who runs NYSE Euronext’s options business, said the “flash crash” indicated there were bigger and more serious structural issues for regulators, such as the existence of “dark pools” for share trading.
“There has to be a more consistent market structure than simply incentives for market-makers,” Mr Boyle said.
Bill Brodsky, chief executive of the Chicago Board Options Exchange, said the Securities and Exchange Commission’s report on the “flash crash”, which pinpointed a single trade by Waddell and Reed, a Kansas City-based firm, was suspect.
“The SEC never figured out what happened on May 6,” Mr Brodsky said. “The SEC report just doesn’t add up in my view.”
In the absence of any argument to support the idea that structural issues were at the root of the crash, I’ll have to dismiss Ed Boyle’s remarks as self-serving.
Brodsky’s remarks were also reported by Reuters:
“We went on for months and months and still didn’t know what happened,” William Brodsky, chief executive of Chicago Board Options Exchange parent CBOE Holdings Inc (CBOE.O), told a Futures Industry Association conference.
The report’s explanation of the May 6 crash “just doesn’t add up in my view,” he said on Thursday
…
Brodsky, who recently headed up the World Federation of Exchanges, criticized the report’s “vague reference to a Kansas City firm (Waddell),” adding, “we need to know what happened across all markets” that day.“We failed because it took so long to figure out what happened, and they never figured out what happened,” he said of the CFTC and the SEC, which is expected to make further changes to the marketplace to avoid a repetition of the crash.
The Wall Street Journal continues to tout “order toxicity”:
“Complementary to circuit breakers based on price action, they could have circuit breakers based on our metric,” said Marcos Lopez de Prado, one of the authors of the study released last month and head of high frequency futures at hedge fund Tudor Investment Corp.
The study has already caught the attention of regulators as they look for ways to avoid another flash crash, especially given that Maureen O’Hara, one of the Cornell professors that co-authored the study, is a member of the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues. The committee’s first task after it was formed in mid-May was to review the market events of May 6, when stock prices fell dramatically before staging a rapid rebound, and make recommendations related to market structure issues that may have contributed to that day’s volatility.
Richard Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority, mentioned the study Friday during a meeting of the Joint CFTC-SEC Advisory Committee. Ketchum noted that a way for market participants to predict toxicity and hedge accordingly “could be really valuable.” The question, he said, is “how do you create an environment where people can offload some of that toxicity risk?”
That ain’t the question, Ketchum. The question is “is it possible to predict future toxicity?”. As has been noted on PrefBlog there is not a shred of evidence in the paper regarding predictive power of “Order Toxicity” – it’s just another piece of Technical Analytical gargage (fifty year old technical analytical garbage, at that) that explains everything and predicts nothing. But one of the authors has good political connections, so we haven’t heard the last of it.
Meanwhile, an executive with the CME has flatly contradicted a central element of the SEC report’s conclusions:
An algorithm-powered order to sell 75,000 futures contracts linked to the S&P 500 stock index, entered by a mutual fund as the session’s volatility ramped up, did take into account price and time parameters, according to Scot Warren, managing director of equity indexes for CME.
“This was a sophisticated algorithm that took time and price into consideration,” said Warren, contesting descriptions of the trade as an emergency bet that helped spark a rout in stock prices.
Warren said the session’s activity revealed a “fundamental supply and demand imbalance” that spooked buyers from the market.
The second paragraph above is a bit puzzling, because the part that says he is “contesting descriptions” is not a direct quote – it might very well be the reporter’s interpretation. If somebody really, really, needed to unload 75,000 contracts, then I am prepared to believe that the algorithm executed this task in an efficient manner – the same way I would unload 100,000 horribly illiquid preferred shares in a day if the client insisted on it (after acknowledging in writing that I considered it a really stupid idea!).
The question is, was it really in Waddell Reed’s clients’ best interests to unload 75,000 contracts as quickly as possible? With no limit price? That’s a $4.6-billion trade, which Waddell Reed has defended as being a highly astute hedge based on a keen awareness of risk. You mean to tell me they were $4.6-billion worried about the market in the afternoon of May 6 and were $0.00 worried in the morning? I’m prepared to listen, but to me the whole Flash Crash story is just another tale of a cowboy vaporizing his clients’ money.
The SEC report was discussed on PrefBlog in the post Flash Crash: Incompetence, Position Limits, Retail.