US Exchanges, SEC Mull Anti-Data Glitch Proposals

In an emergency meeting in September, SEC chairman Mary Jo White gave exchanges 60 days to produce recommendations on how to prevent future malfunctions, after a market data publishing glitch led to a three-hour trading halt on Nasdaq OMX’s US equities and options markets on Aug. 22. It later emerged that the outage was caused by a technical issue affecting the exchange’s ability to distribute market data to the securities information processors (SIP) for the UTP consolidated tape, which disseminates quote and last sale prices for Nasdaq-listed securities. A month later, on Sept. 13, US options exchanges were forced to halt trading after a software upgrade for the Options Price Reporting Authority’s feed of consolidated US options quote and trade data caused issues with calculation of the national best bid and offer price. Then, a technical issue resulted in the International Securities Exchange’s main market and secondary options exchange Gemini not being included in the OPRA national best bid and offer (NBBO) feed on Oct. 30.

In response the SEC’s demands, the exchanges have agreed five general recommendations to address market performance and resiliency, including a proposal to deliver improvements to the operational resiliency, interoperability and disaster recovery capabilities of the SIPs, covering the UTP, the Consolidated Tape Association for NYSE-listed securities, and the Options Price Reporting Authority’s consolidated feeds of US options quote and trade data. Early press reports suggested that Nasdaq OMX and NYSE planned to back-up each other’s SIP, though these rumors later proved to be untrue, after the idea was vetoed due to the associated costs and processing requirements, says one source familiar with the situation.

“If you look at the market failure that resulted in the three-hour halt on Nasdaq, the SIP was overpowered by input... and what really came out of that is the realization that there’s a single point of failure in the system,” says Robert Stowsky, senior analyst at research firm Aite Group. “The proposals are attempting to address that—to have a fallback—so that if there’s a failure on one side, they have a backup to keep the systems running… but I would have been very surprised if Nasdaq and NYSE were willing to be that open with each other,” Stowsky adds.

Other recommendations presented to the SEC cover four areas, including: harmonization of the error rules on the options market; development of three core principles—namely transparency, limited discretion, and the coordination of halts/resumptions by the primary markets—for halting the equities and options market; unifying trade-break rules among the exchanges for both equities and options markets, since each exchange currently has different rules for when to halt trading; and refining “kill switch” functionality for shutting off access to firms whose trades appear to be erroneous, to prevent risk and disruption to the markets, according to a joint announcement issued by the US stock exchanges.

Although the proposals represent some progress on the issue, Jim Myers, senior manager of business consulting for trading and risk management at consultancy Sapient Global Markets, says the exchanges have yet to provide enough information on how the goals will be achieved. “They mentioned plans to make the SIPs more robust… [and that] they would talk about ways to improve their failover systems… but there really wasn’t that much hard and fast information about what is going to happen,” Myers says.

However, a source at one exchange says the exchanges have not publicly released full details of their plans because they are awaiting directions from the SEC about implementation. “The way this will get implemented is either by amendments to a national market system plan that have to be approved by the SEC, or by individual rule filings by each exchange—and the SEC has yet to weigh in on any of that. So putting something out in the public domain that hasn’t been through the rigors of the SEC review process didn’t seem to make sense,” the source says.

Going forward, the exchanges are now working on action plans for each proposal, which will then be submitted to the SEC for public comment and official approval. “Transparency will occur after they make those rules public,” Myers says.

The majority of the proposals were originally addressed by Reg SCI (Systems Compliance and Integrity), a regulatory proposal put forward by the SEC in March following market disruptions such as the 2010 Flash Crash and the botched 2012 Facebook IPO. Reg SCI intended to bring in comprehensive policies and procedures regarding exchanges’ technology systems, but after the most recent Nasdaq and OPRA trading glitches this summer, the SEC decided to speed up the introduction of the new rules, Myers adds.

Stowsky says the fundamental question remains whether the capital markets industry can develop best practices for building market infrastructure or whether these need to be codified into regulation, but also warns that changes to market infrastructure should not be rushed for the sake of appeasing public perception. “A lot of this is about public perception…. Regulators need to do something to address the public’s concern about how the markets are being perceived right now, and they could be satisfied if the industry can come up with best practices. This goes to the very basis of our markets and how they interact, so I’d hate to see something like an arbitrary deadline get in the way of thinking strategically about how to address the issue,” he adds.

The exchanges are expected to make further progress with the proposals in the first quarter of 2014 and will make ongoing changes during the course of the year, sources say.