SEC, CFTC to Issue September Report on 'Flash Crash'

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Advisory Committee on Emerging Regulatory Issues

SEC Chairman Mary Schapiro said at the third joint committee meeting held August 11, which focused on retail investor perspectives and the role exchange-traded funds (ETFs) may have played in the "flash crash" on May 6, that as part of the SEC and CFTC review of market events on that day, the agencies are pursuing two related courses of inquiry. The first, she said, "is empirical and data driven. SEC staff has been reviewing raw transaction and order data, order book 'snapshots,' trade summaries, information about broken trades, and information related to initiation of LRPs and self-help."

The second review, she said, is focused on "extensive interviews with market participants -- their first-hand accounts of what occurred on May 6 and their responses to those events." These efforts, she continued, will be included in the SEC-CFTC joint report that will be presented to the agencies' joint regulatory committee next month and also shared with the public.

Noel Archard, a managing director at BlackRock and head of the product team for Blackrock's U.S. exchange-traded fund (ETF) business, was a panelist at the August 11 meeting. He noted that growing size of the ETF market, stating there are currently 985 exchange traded products available in the U.S. market with $797 billion in assets invested, which represent 30% of the total volume traded on national exchanges.

While ETFs holding U.S. fixed-income securities and non-U.S. equities "were largely unaffected and generally traded at prices within normal ranges of underlying asset values" on the day the "flash crash" occurred, he said. "Many ETFs holding U.S. equities, however, did not. In our view, four different factors simultaneously contributed to market prices for some ETFs diverging from underlying asset value." First, there was a sudden market freefall in U.S. equity prices, which preceded the fall in ETF prices. Second, anxiety over potential trade cancellations caused liquidity providers to fear that normal ETF hedging strategies would be interrupted. Third, "there was market fragmentation where exchange protocols and order routing rules increased selling pressure." And fourth, there was "unintended selling because stop-loss orders were triggered, which increased the volume of sell orders on ETFs."

BlackRock believes that "the final impact on investors was relatively limited due to widespread trade cancellations," however, "there was nonetheless an impact," Archard said. To better understand the effect on financial advisors, BlackRock's iShares ETF business commissioned a survey of 380 retail financial advisors in late June. The survey, he said, "revealed that the majority of advisors were minimally impacted by the market disruption, and they believe that market structure issues, such as an over reliance on computer systems and some types of high frequency trading, were the primary drivers of the crash."

Schapiro reminded attendees of the immediate policy responses the SEC took following the May 6 market crash. First, she said, the SEC worked with the exchanges and FINRA to develop new stock-by-stock circuit breaker rules. These rules, which were approved by the SEC on June 10, "require the exchanges and FINRA to pause trading in S&P 500 stocks when they experience a 10% change in price over a five minute period."

She said also being considered are steps deemed appropriate "to reduce the risk of sudden disruptions and clearly erroneous trades, including deterring or prohibiting the use of 'stub' quotes by market makers." Also being studied is "the impact of trading protocols at individual exchanges, including the use of trading pauses, price collars, and self-help rules." Finally, Schapiro said, "we are looking closely at other mechanisms that may contribute to a more stable market, such as instituting limit up/limit down mechanisms."

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