Bloomberg News

Coordinate Single-Stock Halts, Marketwide Curbs, Sifma Says

October 28, 2011

(Adds comments from CME Group, Angel and details starting in fifth paragraph.)

Oct. 28 (Bloomberg) -- U.S. circuit breakers that halt futures and securities trading during market plunges should also be triggered when 25 stocks in the Standard & Poor’s 500 Index undergo individual pauses, according to an industry group.

The Securities Industry and Financial Markets Association told regulators in a letter yesterday that expanding the events triggering marketwide halts to include pauses in 5 percent of S&P 500 companies is necessary because the index calculation may become unreliable. The broader halts, adopted after the 1987 stock rout, are currently set off only by crashes.

“Such an approach would make sense given the difficulty of accurately calculating the value of the S&P 500 Index in such circumstances,” Sifma told the Securities and Exchange Commission. It said the agency should analyze data to assess the impact that trading halts in individual stocks “may have on the measurement of the performance of the index,” and decide whether another percentage may be more appropriate.

Regulators and exchanges are overhauling rules adopted a quarter century ago to shut down the equity market and related futures trading during periods of volatility. Among other changes, the New York Stock Exchange, Nasdaq Stock Market and other venues proposed that the curbs be triggered when the S&P 500 falls 7 percent. The circuit breaker is currently set off when the Dow Jones Industrial Average drops 10 percent. The proposal also shortens the length of most halts.

Market Crashes

John Nester, an SEC spokesman, declined to discuss the comments while the commission considers action on the rules.

Regulators have been seeking ways to prevent market disruptions such as the May 6, 2010, plunge in which the Dow briefly dropped 9.2 percent in what came to be known as the flash crash. Rules adopted last year halt trading in S&P 500 and Russell 1000 Index stocks and almost 350 exchange-traded funds when they swing more than 10 percent in five minutes.

The NYSE, Nasdaq and other venues are working with regulators to switch to a so-called limit-up/limit-down plan that prevents trades outside a moving price band based on a security’s average level in the past five minutes. The SEC announced the proposal by the exchanges and the Financial Industry Regulatory Authority in April. That program also includes a provision that halts stocks for five minutes, like the current circuit-breaker system.

Curbing Volatility

Proposals for curbing volatility in individual shares and the broader market were recommended by advisers to the SEC and Commodity Futures Trading Commission in February. They included Joseph Stiglitz, an economist who won the Nobel Prize; David Ruder, a former SEC chairman; Brooksley E. Born, who was chairman of the CFTC; and John J. Brennan, chairman emeritus and senior adviser at Vanguard Group Inc.

Changes to the marketwide volatility curbs and the planned shift from individual-stock circuit breakers to a system that limits price moves without immediately halting trading should work together, Sifma said. The group said the new standards should also “be coordinated with trading halts in the futures markets.” If that’s not done, the changes to the marketwide circuit breakers “will be seriously undermined,” Sifma said.

Too Much Complexity

The operator of the Chicago Mercantile Exchange, which offers trading in futures on the S&P 500, disagreed. It told the SEC in an Oct. 25 letter that halting all futures and securities when a “sufficient number” of curbs on individual stocks are triggered would exacerbate uncertainty in a crisis. U.S. regulators must study how curbs for individual stocks would affect index prices and trading in related products such as ETFs, Craig Donohue, the chief executive officer of CME Group Inc., has told the SEC in letters over the past year.

“CME Group believes that this would add even greater complexity and uncertainty given the market capitalization weighted construction of the index,” Donohue wrote on Oct. 25, referring to the S&P 500. “Failing to holistically examine and understand the interaction of these different volatility mechanisms prior to implementation is akin to deploying an untested trading algorithm in the marketplace.”

Donahue said the securities exchanges should adopt automated mechanisms to limit volatility without pausing stocks. That would decrease uncertainty among market participants, he said in the letter.

Liquidity Providers

CFTC Commissioner Bart Chilton told the SEC in a letter dated Oct. 25 that he was “apprehensive” about how a market plunge would affect the interaction between the curbs for individual stocks and the broader market. The interplay of those restraints may fuel uncertainty, make it harder for investors and brokers to manage risk and “cause liquidity providers to leave the market when they are needed the most,” he said.

The marketwide circuit breaker has only been triggered once, on Oct. 27, 1997. The curbs at the time were based on declines in the Dow average of 350 points and 550 points. They went off twice that day, first at 2:35 p.m. and then at 3:30 p.m. The second halted trading for the rest of the session.

Sifma and the CME highlighted other concerns to the SEC about the three trigger levels and when they can occur. S&P 500 declines of 7 percent, 13 percent and 20 percent from the prior day’s close would set off halts across all markets, narrowing the current thresholds of 10 percent, 20 percent and 30 percent in the Dow average, according to the SEC.

7% Breaker

The proposed 7 percent circuit breakers would have been triggered 10 days since October 1987, according to data compiled by Bloomberg. Those dates include the May 6, 2010, rout and five days in October 2008, the month after Lehman Brothers Holdings Inc.’s collapsed, the data show.

James Angel, a finance professor at Georgetown University’s business school in Washington, questioned the use of a 7 percent level, saying that number was based on “no real economic analysis.” Trading would have halted on the first day trading resumed after the Sept. 11 terrorist attacks and repeatedly during the financial crisis in late 2008, he said in a phone interview. “It’ll kick in when we don’t want it to.”

In an Oct. 25 letter to the SEC he said the marketwide circuit breakers should be based on how fast a market plunge occurs, like the current single-stock circuit breaker program. Regulators should also consider marketwide trading halts at the request of the SEC, Finra, Federal Reserve and U.S. Treasury Department, he said.

--With assistance from Silla Brush in Washington. Editor: Chris Nagi, Nick Baker

To contact the reporters on this story: Nina Mehta in New York at nmehta24@bloomberg.net; Jesse Hamilton in Washington at jhamilton33@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net.


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