Flash Crash Anniversary: Are We Safer?
The good news: we haven't had another Flash Crash, and rules implemented since the Crash have likely reduced the severity of future crashes.
The bad news: the system is still creaky and vulnerable to individual stock mini-disruptions and security breaches, and there is a serious systemic risk from derivatives that has not gone away.
Also: the potential consolidation of exchanges does raise regulatory issues around how much trading influence should be concentrated in one combined exchange.
First, let's give the SEC some credit.
1) After the crash, the first thing they did was implement individual stock circuit breakers for the S&P 500. That was first implemented in part in June, a month after the Flash Crash, and has since been expanded to the Russell 1000, and several hundred ETFs.
A month ago, the SEC released a proposal for a limit-up, limit down rule. This is a refinement of the single stock circuit breakers that is used in the futures market. It would establish a trading band for price movements; trading outside the quotes would be rejected, while those inside would be accepted.
How is this different from the current single stock circuit breaker rule? Under the current rule, if a single stock trades 10 percent above or below it's average price in a 5-minute period, trading in that stock is halted for 5 minutes.
The issue: why halt trading at all? Under the limit-up, limit down rule, trading would be allowed to occur within a band, say trading could occur if the stock traded 10 percent above or below the average price in that five minute period. Outside that, trading could not occur for a set time period.
The advantage: it's less disruptive! It eliminates the crazy quotes; trading is not halted.
This rule will come into force soon — the comment period will end shortly, and will likely debut in September.
One other point: single stock circuit-breakers should be expanded to cover the entire stock universe.
2) The exchanges have implemented uniform clearly-erroneous trade rules that at least requires everyone to abide by the same rules should trades by busted. This is a good move, but why have so many busted trades in the first place? Why not create rules that prevent them from happening? So if the price is, say 30 percent away from the average trade in the last 5 minutes, that could easily be incorporated to prevent those trades from being executed at all.
In a sense, this is what limit up/limit down does: it does not allow you to print orders outside a band.
3) On February 28, 2011 new short selling rules went into effect, requiring that if a security declines by 10 percent from its previous night's close, short selling in that security will only be allowed above the current best bid for the remainder of that trading day and all of the following day.
More New Rules Ahead
4) The SEC has banned naked access, which goes into effect July 14, which will prevent high frequency traders from gaining direct access to exchanges...all trades will have to pass through a broker dealer and do mandatory risk checks.