(Reuters) - Last year’s “flash crash” brought to a boil a debate over stability and fairness in the U.S. equity marketplace.
On May 6, 2010, the Dow Jones industrial average plunged nearly 700 points in just minutes before rebounding, sending blue-chip stocks sharply lower and briefly wiping out an estimated $1 trillion in market capitalization.
For some, the unprecedented market drop confirmed fears that high-speed, automated trading represents a systemic risk to the foundations of capitalism. For others, it was an embarrassing blip that called for measured adjustments to an otherwise well-functioning market.
The U.S. Securities and Exchange Commission responded with some quick fixes, such as new trading pauses known as circuit breakers, and vowed to investigate a bevy of emerging concerns in the complicated and fragmented stock market.
On February 18, a special committee of experts made recommendations on how to avoid another crash, based on an 87-page regulator report issued last September.
Regulators have meanwhile taken the unprecedented step of asking high-frequency trading firms to hand over the details of their trading strategies and in some cases, their secret computer codes.
Here is an overview of adopted, proposed and possible changes to the marketplace, all of them in some way influenced by the flash crash:
* New marketwide single-stock circuit breakers: A 5-minute halt to trading in all U.S. shares and exchange-traded funds (ETFs) when they move more than 10 percent in 5 minutes. The breakers, which were adopted after the crash and expanded twice, are less stringent for less liquid stocks.
* Large trader reporting: The market’s most dominant players, measured by trading volume, will now have special identifiers and be required to give regulators more information on their activities. Under consideration for decades, the rule was finally adopted by the SEC in July.
* A ban on “stub” quotes: Many of these orders, which are well off the public prices of stocks — even as low as a penny a share — were executed during the flash crash.
* Tighter rules for market makers: As part of the stub quote ban, registered market makers must submit quotes no more than 8 percent away from the best bid or offer for stocks covered under the new circuit breakers, and no more than 30 percent away for other securities.
* A ban on “naked” access to markets: Brokerages are no longer permitted to provide high-frequency traders unfettered, or “naked,” access to the marketplace; instead, they are required to monitor traders’ activity for erroneous or other potentially damaging orders.
* Clarifying “clearly erroneous” trades: a standard definition of trades that exchanges will cancel if executed, based on how far they are away from the public stock price. This gives investors clarity they didn’t have immediately after the crash.
* “Limit up-limit down”: Set to replace the new circuit breakers, this mechanism would set floating floors and ceilings for stocks, providing temporary price safeguards without halting trading outright. The special committee backed this idea in February, and it was formally proposed in April.
* Consolidated audit trail: Under development before the flash crash, this record of all U.S. stock trading activity should help regulators better understand and police markets. The need to aggregate data from dozens of exchanges and trading venues delayed the regulator report on what caused the crash.
* Ban flash orders: Proposed in 2009, this would eliminate the practice of exchanges “flashing” some orders to a select group of professional trading firms before routing the orders to rival venues. The SEC extended debate on this rule in July, 2010, focusing on its impact on options markets.
* Tighter rules for “dark pools”: Also from 2009, three separate proposals would have the effect of bringing more transparency to these private trading venues that anonymously match buyers and sellers, allowing investors to trade larger blocks of stock while hiding their intentions from the wider marketplace.
* Obligations and privileges for high-frequency market makers: Measures that would compel short-term traders to provide liquidity, or the availability of buy and sell orders, to the market even in times of crisis. The committee suggested a “peak load” pricing scheme during stressful times.
* Tightening index-based circuit breakers: Also backed by the committee, these long-standing U.S. trading halts did not trip during the flash crash.
* Cross-asset circuit breakers: Revamping and syncing trading halts between the equities and futures markets. The flash crash rapidly spilled over from futures, which were eventually halted, to stocks, which were not.
* A “trade at” rule: This would prohibit any of the dozens of U.S. venues and wholesale market makers from executing an incoming order unless they were already publicly displaying the best bid or offer in that particular stock, or unless they improved the price by a set amount. The committee asked regulators to consider adopting such a rule.
* Crackdown on high-frequency strategies: Regulators have said they are probing the intentions of some rapid-fire traders, including the possibility that they have intentionally exacerbated volatility or have unlawfully exploited the deeply fragmented stock market.
* Fees or restrictions on orders: SEC Chairman Mary Schapiro has expressed concern that the vast majority of orders sent into the marketplace are immediately canceled, and her agency has probed “quote stuffing” and unusual “spikes” in traffic. One possibility is a minimum life-span for orders of perhaps a half-second, a relatively long period of time in electronic trading. The committee suggested fees for order cancellations.
* New rules for “marketable” orders: These orders, usually from individual investors, are to buy or sell a security regardless of its price. Regulators said a flood of sell-at-any-cost orders had exacerbated the flash crash.
* Transaction tax: The idea of a new U.S. tax on all transactions was floated in 2009 but has since faded; it would face fierce resistance from the industry. Still, U.S. regulators and lawmakers are likely watching for signals from the European Union, which is now pushing for such a tax.
Reporting by Jonathan Spicer; Editing by Tim Dobbyn