Flash Crash Committee — What to Expect

Flash Crash Advisory Commission supports supplementing single stock circuit breakers, consolidated audit trail. The Flash Crash Commission (officially the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues) is meeting this morning...and surprise! The Advisory Committee has issued a summary report...really a series of recommendations.

Recall that the staff of the Joint Committee also issued a report in September of last year, where they pinned much of the blame for the Crash on one large institutional order in the S&P E-mini futures market.

What caused the Flash Crash? You won't find it in this report. It's really a series of recommendations on tweaking our creaky market structure. Here's a few highlights.

1) first, they support the single stock circuit breakers that were implemented right after the Flash Crash, but recommend they be supplemented with a limit up/limit down rule that would allow the stocks to trade within bands rather than be completely halted.

2) they recommend implementation of a consolidated audit trail for the US equity markets--the SEC was embarrased when they were unable to get access to trading data readily in the wake of the Flash Crash.

Both of these recommendations were widely expected and are likely to be implemented. Much of the rest of the report consists of attempts to get high frequency traders and market makers to behave better.

3) on market makers, the Committee wants the SEC to evaluate whether incentives or regulations should be developed to encourage "persons who engage in market making strategies" to provide quotes that are "reasonably related to the market." This is about as wimpy as a recommendation can get, but hey , it's an Advisory Committee.

4) regarding high frequency traders, the Committee recommends the SEC and CFTC should consider imposing a fee based on the average of order cancellations to actual transactions that are done by a high frequency trader. This is hotly debated in the industry; critics claim it will destroy the profitability of high frequency trading.

5) they recommend changes to the present system-wide circuit breakers: reducing the initial trading halts to a shorter period of time, allowing the halt to be triggered as late as 3:30 PM, and using the S&P 500 as the triggering mechanism rather than the Dow.

The currently halt occurs if the Dow declines 10% before 2:00 p.m., the markets halt for one hour; between 2:00 and 2:30 p.m. they halt for 30 minutes; after 2:30 p.m. there is no halt. If the Dow declines 20% before 1:00 p.m., the markets halt for two hours; between 1:00 and 2:00 p.m. they halt for one hour; after 2:00 p.m. the markets close for the day.

This is a sensible recommendation.

6) The Committee supported the SEC's decision to ban "naked access" and require that all direct access order routing occur through a registered broker-dealer.

7) The Committee recommends the SEC should consider making changes in the current maker/taker pricing practices, including building in incentives for the Exchanges to provide for "peak load" pricing models.

The entire "maker/taker" model is a mess, in my opinion. Want to clean the market up? Eliminate payment for order flow.

8) regarding internalization, recomends that the SEC should conduct "further analysis" and consider adopt its rule proposal requiring that internalized or preferenced orders only be executed at a price materially superior (e.g., 50 mils for most securities) to the quoted best bid or offer.

Again, this is a sensible recommendation. Enough of internalizers offering phony price improvement by one one-hundredth of a penny.

9) The Committee further recommends analysis of the current "top of book" protection protocol and the costs and benefits of its replacement with greater protection to limit orders placed off the current quote or increased disclosure of relative liquidity in each book.

Again, a sensible recommendation.

The Joint Committee is meeting this morning at 9:30 AM.

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