The volatility that hit exchange-traded funds last Aug. 24 offers a “great opportunity” for regulators to assess the initiatives put in place after the 2010 Flash Crash, according to Richard Ketchum, chairman and CEO of the Financial Industry Regulatory Authority.
In his prepared remarks, to be given during a Thursday morning hearing before the Senate Banking Subcommittee on Securities, Insurance and Investment, Ketchum states that given the ETF volatility of Aug. 24, five issues should be up for a review:
The opening processes on primary listing exchanges;
The operation of the limit up/limit down at the opening of trading, at re-openings after a trading pause and when the price is rebounding;
The use of single market prices rather than consolidated prices for index calculations at times when the primary market opens outside its normal process;
The use of stop orders, which become market orders when triggered and can execute at a price substantially worse than anticipated by the investor, particularly in volatile markets; and
Whether market maker quoting obligations are stringent enough to promote market stability.
Ketchum stated in his prepared testimony that regulators had “an excellent opportunity” to evaluate the effectiveness, for instance, of the exchanges’ limit up/limit down initiative, which addresses the type of sudden price movements that the market experienced during the flash crash.
Under the plan, he explained, “a limit up and limit down mechanism prevents trades in [National Market System] stocks from occurring at prices outside of certain ranges.”
The events of Aug. 24, when the Dow plummeted more than 1,000 points within the first 10 minutes of trading, did not illustrate “a market out of control, but the value of having appropriate controls in place,” Ketchum says.
“Were it not for the limit up/limit down procedures, the market fluctuations last August would have been more dramatic. There were over 1,200 trading pauses that day, with over 1,000 occurring in exchange-traded products, many which were repeats in the same ETP.”