SEC Circuit Breaker Doesn't Go Far Enough

The US Securities and Exchange Commission's (SEC's) circuit breaker rules—which the Commission announced June 30 it plans to expand to include more stocks and exchange-traded funds (ETFs)—are a nice try at improving market regulation after the disruption of May 6, but still behind the times.

The circuit breaker rules, implemented earlier in June for stocks listed in the S&P 500 index, pause trading in those stocks if they experience a 10 percent price change over the preceding five minutes. The SEC proposed the rules in tandem with the self-regulatory organizations (SROs) and the Financial Industry Regulatory Authority (Finra).

But the SEC’s aims could be more readily achieved by a 50 millisecond quote expiration rule, as proposed by datafeed provider Nanex, whose executives note that 50 milliseconds is the time required to communicate electronically between New York and California, and the rate at which it is impossible to transmit information any faster.

This being the current environment, five minutes is an eternity. Nanex executives identify "quote stuffing" as the cause of the May 6 disruption. "If you could generate a large number of quotes that your competitors have to process, but you can ignore since you generated them, you gain valuable processing time," says a Nanex spokesperson. Imagine how many quotes a high-frequency trading firm can generate automatically in one full second, much less five minutes.

Along with a 50 millisecond expiration time for quotes, Nanex also proposes that exchanges time stamp quote and trade data upon generation, so delays can be detected, plus a ban on the practice of quote stuffing itself.

The SEC and the SROs would do well to push further with the spirit of what they are putting in place, and shorten the window of time in its circuit breakers, to keep up with market realities.