Yesterday, the SEC/CFTC Joint Advisory Committee on Emerging Regulatory Issues held its first meeting. The Joint Advisory Committee’s members include financial industry experts, with SEC Chairman Mary Schapiro and CFTC Chairman Gary Gensler serving as co-chairs. Monday’s meeting largely centered around a joint SEC and CFTC staff report containing preliminary findings regarding the unusual market activity on May 6, 2010.
In her opening statement, SEC Chairman Mary Schapiro predicted that the analysis of the market volatility on May 6 will show how differing markets, trading conventions and differing rules across markets contributed to the events of that day, which should allow the CFTC and the SEC to fashion appropriately coordinated regulatory responses.
In his opening statement, CFTC Chairman Gary Gensler stated that while the Joint Advisory Committee would initially review recent market volatility, its purpose was “looking around corners – looking into the future about where we need to take regulation.”
The staffs' preliminary report detailed the sudden, rapid decline in the futures and equity markets, which was later followed by a similarly rapid recovery. According to the report, the extreme volatility suggests the occurrence of a temporary breakdown in the supply of liquidity across the markets. In presenting its findings, the staff presented slides graphically depicting the extreme market volatility of the markets that day. The staff also highlighted several working hypotheses and findings:
- possible linkage between the precipitous decline in the prices of stock index products such as index ETFs and the E-mini S&P 500 futures, on the one hand, and simultaneous and subsequent waves of selling in individual securities, on the other, and the extent to which activity in one market may have led the others;
- a generalized severe mismatch in liquidity, as evinced by sharply lower trading prices and possibly exacerbated by the withdrawal of liquidity by electronic market makers and the use of market orders, including automated stop-loss market orders designed to protect gains in recent market advances;
- the extent to which the liquidity mismatch may have been exacerbated by disparate trading conventions among various exchanges, whereby trading was slowed in one venue, while continuing as normal in another;
- the need to examine the use of “stub quotes,” which are designed to technically meet a requirement to provide a “two sided quote” but are at such low or high prices that they are not intended to be executed;
- the use of market orders, stop loss market orders and stop loss limit orders that, when coupled with sharp declines in prices, for both equity and futures markets, might have contributed to market instability and a temporary breakdown in orderly trading; and
- the impact on Exchange Traded Funds (ETFs), which suffered a disproportionate number of broken trades relative to other securities.?
The staff said that they had found no evidence that the events of May 6, were triggered by “fat finger” errors, computer hacking, or terrorist activity, although they could not rule out these possibilities.
Of special interest to the members of the Joint Advisory Committee were the so-called stub quotes – placeholder prices that tend to be far from an actual market price and are never intended to be executed. Several Commissioners and members of SEC and CFTC staff hypothesized that as a result of the severe decline, some trades were suddenly executed unintentionally at stub-quote prices on May 6.