IIROC Issues Flash Crash Review

The Investment Industry Regulatory Organization of Canada has announced its release of the Review of the Market Events of May 6, 2010:

The factors that contributed to the trading patterns are:

  • The existence of large sell imbalances: A number of the securities showed more sell interest beginning at the opening of trading on May 6 and in some cases the ratio of sell volume to buy volume was upwards of 3:1.
  • Electronic trading activity in the securities: High Frequency Traders (“HFT”) and Electronic Liquidity Providers (“ELP”) were trading in a number of the securities reviewed. Although the definitions of the above terms are open to discussion, we are using these terms to identify fast and relatively dominant electronic traders. The review shows that after the sudden sharp decline in the US indices, a number of HFTs and ELPs quickly withdrew from the Canadian market causing a dramatic and rapid decline in available liquidity. This withdrawal was particularly apparent on the buy side putting further pressure on prices. Some HFT entities remained in the market but predominately on the sell side and we noted markedly reduced liquidity. The withdrawal of HFTs and ELPs was particularly apparent in the heavily traded ETFs that were reviewed. IIROC is aware that some of the ELP and HFTs withdrew from the US market due to their concern about significant latencies in their data feeds from the US markets.
  • “Traditional” market makers were not active in the review securities with the exception of the four highly liquid ETFs. IIROC found that market makers were present and fulfilling their obligations on the other securities reviewed including their oddlot and spread goals.
  • The triggering of Stop Loss Orders: In many cases the triggering of Stop Loss Orders was a major contributor to the deeper price declines experienced by a number of the securities reviewed. The analysis suggests that many of the egregious price declines were due to Stop Loss Order activity from Stop Loss “market” Orders as opposed to Stop Loss “limit” Orders.

No data is presented in the report that support any of the conclusions. Trust your regulators! They’re very smart, and beholden to nobody.

Recommendations are:

  • The CSA and IIROC should review the current market wide circuit breaker to determine if the current trigger levels are appropriate and whether an independent Canadian-based circuit breaker level is required.
  • IIROC along with the CSA should investigate whether single stock circuit breakers in the form of temporary trading halts should be implemented in Canada.
  • All marketplaces should adopt volatility controls and the form and the level of these controls should be reviewed to assess to what degree they ought to be harmonized.
  • All IIROC dealers should consider how to effectively manage Stop Loss Orders in the current high-speed, multi-market environment. IIROC firms should also provide their RRs and clients, including those who enter their orders directly on to the marketplace without personalized advice, with guidance on the use of Stop Loss Orders effectively in a high speed, multimarket environment.
  • IIROC should review the current erroneous and unreasonable price policies and procedures, taking into account the experience of May 6.

Circuit breakers? While my natural inclination is that nothing should get in the way of two parties agreeing to a trade, I can’t really get excited over circuit breakers one way or another anyway. When the market gets as wild as it did during the flash crash, the only sensible thing to do is to go out and get a cup of coffee.

It appears that there will be more regulatory paperwork surrounding Stop Loss orders, but we’ll see how that works out. Anybody stupid enough to use a stop-loss order in the first place isn’t going to be impressed by another piece of paper.

Update: The SEC has approved new circuit breaker and trade-busting rules:

The Securities and Exchange Commission today approved new rules submitted by the national securities exchanges and FINRA to expand a recently-adopted circuit breaker program to include all stocks in the Russell 1000 Index and certain exchange-traded funds. The SEC also approved new exchange and FINRA rules that clarify the process for breaking erroneous trades.

A list of the securities included in the Russell 1000 Index, which was rebalanced on June 25, is available on the Russell website. The list of exchange-traded products included in the pilot is available on the SEC’s website. The SEC anticipates that the exchanges and FINRA will begin implementing the expanded circuit breaker program early next week.

For stocks that are subject to the circuit breaker program, trades will be broken at specified levels depending on the stock price:

  • For stocks priced $25 or less, trades will be broken if the trades are at least 10 percent away from the circuit breaker trigger price.
  • For stocks priced more than $25 to $50, trades will be broken if they are 5 percent away from the circuit breaker trigger price.
  • For stocks priced more than $50, the trades will be broken if they are 3 percent away from the circuit breaker trigger price.

Where circuit breakers are not applicable, the exchanges and FINRA will break trades at specified levels for events involving multiple stocks depending on how many stocks are involved:

  • For events involving between five and 20 stocks, trades will be broken that are at least 10 percent away from the “reference price,” typically the last sale before pricing was disrupted.
  • For events involving more than 20 stocks, trades will be broken that are at least 30 percent away from the reference price.
  • One Response to “IIROC Issues Flash Crash Review”

    1. […] The recent IIROC report trumpeted Canadian-style depth-of-book protection. Vanguard believes the Commission should consider the costs and benefits of a “trade-at” rule in which a trading center that was not displaying the NBBO price at the time a marketable order was received could either: “1) execute the order with significant price improvement (such as the minimum allowable quoting increment (generally one cent)); or 2) route lSOs to full displayed size of NBBO quotations and then execute the balance of the order at the NBBO price.” […]

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