2010 Year in Review: Regulations Bite After Flash Crash Data Backlash

Regulators on both sides of the Atlantic grappled with major reforms during 2010 that will have long-lasting implications for market data consumers and the capital markets as a whole.

Following its scrutiny of flash orders and dark pools of liquidity in late 2009, the US Securities and Exchange Commission began 2010 with a fundamental review of equities market structure, mandating increased risk management around naked access—where broker-dealers provide clients with unsupervised access to exchanges using their infrastructure—which the SEC estimated accounts for 38 percent of daily trading in US equities, and other practices central to low-latency trading, including high-frequency trading and co-location (IMD, Jan. 15).

With this already underway, on May 6, economic uncertainty in European markets, a rogue order and a frenzy of high-frequency trading in response precipitated a “Flash Crash,” which saw unprecedented intra-day price swings in US equity markets, almost wiping out some stocks’ value entirely before restoring them to pre-crash levels within minutes.

In response, the SEC proposed a real-time consolidated audit trail of equities and options trade data designed to detect anomalies or abusive trading activity—though the plan received a mixed response from the industry on its practicality and cost.

The SEC issued its official review of the Flash Crash on Sept. 30, suggesting a more coordinated approach towards circuit breakers, which temporarily halt trading in a stock if its price level fluctuates too rapidly, and criticizing the use of stub quotes—a gesture to trade designed to fulfil quoting obligations but at bid-and-offer prices that diverge significantly from the current BBO—which the SEC concluded exacerbated price fluctuations “as liquidity completely evaporated in a number of individual securities and ETFs,” causing trades to be executed “at irrational prices as low as one penny or as high as $100,000.” The SEC outlawed the practice of stub quotes shortly after issuing its report (IMD, Nov. 12).

Other industry commentators blamed another practice known as quote stuffing, whereby market practitioners generate vast amounts of quote messages with the intention of overloading market infrastructure, causing latency spikes.

Although the SEC found no evidence of this on May 6, the practice appears to have concerned European regulators, as the European Commission’s MiFID 2 consultation paper includes recommendations to curtail any undue quoting practices, by requiring market operators “to ensure that orders would rest on an order book for a minimum period before being cancelled” or that “the ratio of orders to transactions executed by any given participant would not exceed a specified level.”

The consultation paper also includes a swathe of other recommendations to improve transparency in European capital markets. For example, the EC has proposed a consolidated tape—or tapes—of post-trade equities data (see story, below), shortening delay periods for reporting OTC equity trades, extending equity market transparency requirements to include “equity-like” instruments, implementing new pre- and post-trade transparency obligations for bonds, structured products and OTC derivatives markets, requiring broker crossing networks to publish their venue ID in post-trade reports, and requiring commodities trading venues to publish aggregated positions by trader type to monitor speculative trading activity in commodities markets (IMD, Dec. 13).