IOSCO-UPDATE 2-More market coordination needed after flash crash

* May 6 exposed lack of linkage in U.S. marketplace

* SEC approves "circuit breaker" rules

* Issuers should be at center of rule changes, TMX says (Adds comments from SEC, other details)

By Jennifer Kwan and Rachelle Younglai

MONTREAL, June 10 (Reuters) - Stiffer coordination of rules for exchanges and alternative trading venues is needed to help prevent another "flash crash," heads of industry warned on Thursday.

A major flaw that emerged from the market's mysterious skid on May 6 hinged on the "lack of linkage" between all the various markets in the United States, said Gary Cohn, president of Goldman Sachs Group Inc (GS.N). He said unlevel policies in various segments of the marketplace essentially resulted in a situation where "volume moved to other sources of liquidity."

"We need a much better coordination across the national market system," Cohn said at a conference in Montreal.

On May 6, the Dow Jones industrial average .DJI, already down about 300 points, plunged some 700 points in minutes in afternoon trading before sharply rebounding, highlighting the fragmented U.S. marketplace where some 50 different exchanges and other venues compete fiercely for the high-speed order flow.

"One of the most interesting points was literally how quiet it was on all of our trading floors around the world in that 30-minute period. I think the vast, vast majority of the people sat there with their jaws wide open, watching the screen in disbelief trying to figure out what was going on," said Cohn, referring to derivatives markets.

U.S. regulators and major exchange operators are still trying to pinpoint the cause of the flash crash. In the interim, they have proposed improving surveillance of trades and clearer rules for canceling unusual trades.

NEW CIRCUIT BREAKERS JUST A START

The Securities and Exchange Commission on Thursday approved new so-called circuit breakers, essentially a mechanism to pause trading when markets are in freefall, and exchanges could implement the new rules as soon as Friday. [ID:nN10593125]

"They are an important step forward for us. They are a direct response to May 6, but they also, I think, help us try to knit together these very fragmented trading venues in a way that should help protect investors," SEC Chairman Mary Shapiro told the conference, sponsored by the International Organization of Securities Commissions, known as IOSCO.

The stock-specific circuit breakers will halt trading for five minutes in S&P 500 shares if the shares fall more than 10 percent in five minutes. The SEC also intends to adjust existing index-based breakers, which did not trip on May 6.

Tom Kloet, chief executive of the TMX Group Inc (X.TO), which runs the Toronto Stock Exchange and junior Venture Exchange, said circuit breaker rules are a good first step, but don't go far enough.

He suggested regulators consider crafting rules that put in the forefront the interests of issuers, and force alternative trading systems (ATSs) to also adhere to those interests.

"The issuing community is not happy to see that kind of gyration in their stock in that kind of period," he said at the conference of the International Organization of Securities Commissions (IOSCO).

"Some issuers say, 'How can these guys (ATSs) distort the price of my stock? I don't know who they are. I didn't sign up to be traded on their market.'"

John Lowrey, chief executive of Chi-X Global, a top ATS, said there should be an obligation to issuers, but regulators should be the ones to dictate what that should be.

"There's no doubt that if a security is being traded in a go-slow mode on one exchange, the other exchanges should fall into step. There has to be a rule set around what the obligations of the other exchanges are and those rule sets have to be well known and well understood prior to an event," Lowrey said.

MARKET MAKERS IN GOOD TIMES AND BAD

There was also debate over whether regulators should saddle market-making firms with obligations to keep trading in both good times and bad. These firms essentially take both sides of the market, providing it liquidity.

Some large traders that use market-making strategies stopped trading during the worst of the crash, likely making it even worse.

"If you're going to have the advantages of being a market maker, you better have the obligation of being a market maker in good markets and bad markets, and not have the ability to turn off your machines when things get too chaotic," Goldman's Cohn said. (Reporting by Jennifer Kwan and Rachelle Younglai; Additional reporting by Jonathan Spicer; Editing by Jan Paschal)