Industry Seeks Market-Wide Circuit Breakers

NEW YORK—Following the largest intraday drop in the history of the Dow Jones Industrial Average (DJIA), which occurred on May 6, operators of the New York Stock Exchange (NYSE) suggest that market-wide circuit breakers could prevent similar occurrences in the future and industry members are warming to the idea, according to officials.

The NYSE can and did use liquidity refreshment points (LRPs) to switch certain NYSE-listed stocks from automated to auction, or manual, trading mode on May 6, but without a universal circuit breaker, other markets were able to bypass NYSE’s manual markets for certain stocks on May 6, according to Larry Leibowitz, group executive vice president and head of U.S. execution and global technology for NYSE operator NYSE Euronext, during congressional testimony last week.

A NYSE circuit breaker halts all U.S. equity markets if all the DJIA falls by 10, 20 or 30 percent, under an agreement by these markets to honor and follow the NYSE’s action.
“Markets effectively chose to ignore and trade around our quotes once our circuit breakers were triggered,” said Leibowitz. “The events of May 6 have demonstrated that it is time to reconsider the ability of markets to trade through functioning quotes.”

The notification technology being used by the exchanges and venues in tandem with circuit breakers will have to change, according to Jeff Wecker, president and CEO of Lime Brokerage. “The initial trigger that causes the suspension of trading really rests in the realm of the market centers,” he says. “If the market is suspended, we would ideally like a message from that market center for a given name that the market has been suspended so we can properly use that information in informing our customers.”

A stock-specific circuit breaker like those operated by the NYSE is a “very appropriate response,” says Wecker. “Had that been in place market-wide, we think some of the activity we saw that day—certainly the trading at its steepest point of decline—may have not happened, because it may have given buyers and sellers a chance to catch their breath and enter the market.”

Agency broker Knight Capital Group also supports circuit breakers for individual stocks, according to Thomas Joyce, chairman and CEO. “Once an individual stock drops 25 percent from the previous day’s close, then trading should be halted for five minutes,” he says. “It is critical to our recommendation that this circuit breaker and any subsequent trading halt be applied across all market centers uniformly. All market centers must operate with a consistent approach during periods of dislocation. This will prevent any traders from circumventing the process and keep investors away from very thin secondary markets where prices can be damaged rapidly.”

After meeting with representatives of major exchange operators—NYSE Euronext, Nasdaq OMX, Bats Exchange, Direct Edge, the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE)—and the Financial Industry Regulatory Authority (Finra) to discuss the causes of the May 6 market events, potential contributing factors, and possible market reforms, Mary Schapiro, chairperson of the U.S. Securities and Exchange Commission (SEC), announced last week plans to develop a framework to address these issues. “As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades,” she said.

At press time, the U.S. Securities and Exchange Commission (SEC) has not yet issued a promised framework, the plans for which Schapiro announced on May 10.

The extent of software development that would be needed to support circuit breakers for venues that do not have them at the level as NYSE does could vary widely, according to Lime’s Wecker. “The question of responsibility for who does what software development work depends on the nature of how the re-starting of trading in a name that’s been halted occurs,” he adds.