(Bloomberg) -- The U.S. Securities and Exchange Commission approved Nasdaq Stock Market’s request to set trading curbs for individual stocks, adding to the market-wide circuit breakers already in place.
The measure, which will halt trading on the exchange for a minute if a stock’s price rises or falls more than a set threshold over a 30-second period, aims to curtail “abrupt and significant” price movements resulting from potentially aberrant volatility, Nasdaq OMX Group Inc. told the SEC in June. Circuit breakers for individual securities introduced in June provide coordinated trading halts across all markets when prices move 10 percent over a five-minute period.
The exchange proposed the curbs for stocks in the Nasdaq- 100 Index after the May 6 plunge that briefly erased $862 billion in equity value. While the SEC decided to allow the Nasdaq pauses because they’re similar in purpose to the New York Stock Exchange’s curbs called liquidity replenishment points, which have operated on that market for years, it also said both volatility constraints may eventually be eliminated.
The SEC is working with stock exchanges and the Financial Industry Regulatory Authority “to develop an appropriate consistent cross-market mechanism to moderate excessive volatility that could be applied widely to individual exchange- listed securities,” the agency said in a March 11 notice. The completion of that initiative may also end the use of NYSE’s LRPs and Nasdaq’s volatility curbs, it said.
Trading Curbs
Under the Nasdaq program, stocks with prices up to $25 would be delayed on Nasdaq for a minute when shares move at least 10 percent in 30 seconds. In most cases, such swings would halt trading on all venues because they would also trigger the SEC’s nationwide circuit breakers. Companies above $25 could see trading paused on Nasdaq for moves of less than 10 percent. Those stocks would stop when shares move 5 percent or 3 percent, depending on the price, Nasdaq said.
Deutsche Bank AG and the Securities Industry and Financial Markets Association, which represents the interests of brokers and banks, criticized the use of different constraints and rules on different markets, which they said may confuse investors and limit the effectiveness of the single-stock circuit breakers.
“Nasdaq’s volatility guard system would create another situation where a market imposes a discrete trading pause that is not used by other markets trading the stocks,” Jose Marques, New York-based global head of electronic equity trading at the Frankfurt-based bank, told the SEC on July 21. “These differences between the markets lead to confusion among market participants, particularly in times of market stress, leading to increased volatility.”
No Evidence
The SEC said critics of Nasdaq’s proposal provided no evidence to support their claims. It also said the Sept. 30 joint report on the May 6 crash by the Commodity Futures Trading Commission and SEC found that NYSE’s LRPs didn’t exacerbate price moves, despite initial speculation from exchange executives that the curbs were partly to blame for rapid declines in some securities as traders ignored the Big Board and routed orders to other markets that had less liquidity.
The SEC said Nasdaq’s pilot program of volatility curbs may be implemented “without delay.” Silvia Davi, a Nasdaq OMX spokeswoman, didn’t respond to an e-mail sent yesterday asking when the exchange would institute the curbs.
Reducing Volatility
“LRPs were developed to reduce volatility, as evidenced by their success on May 6,” Ray Pellecchia, a spokesman for NYSE Euronext, said in an e-mail. “We will continue to monitor their effectiveness and role as additional marketplace enhancements such as circuit breakers and limits are introduced.”
Circuit breakers for individual stocks were implemented in June for companies in the Standard & Poor’s 500 Index and expanded in September to the Russell 1000 Index and more than 300 exchange-traded funds. The SEC has been working to expand the curbs and adjust them to incorporate a limit-up, limit-down mechanism that prevents shares from moving beyond a certain threshold instead of immediately halting trading across markets.
Such a system, which is used in some U.S. futures markets, allows trading to continue within a price band for some time instead of immediately preventing investors from buying or selling the stock. Some shares including in actively traded stocks such as Citigroup Inc. have been halted by a single transaction outside the 10 percent threshold.
Circuit Breakers
Measures to curb volatility on NYSE and Nasdaq, as well as the SEC’s market-wide circuit breakers, apply to individual securities. Another circuit breaker governs all securities and futures trading when the Dow Jones Industrial Average falls at least 10 percent from the prior day’s closing price. Last month another curb went into effect for short sales, which is intended to reduce rapid price declines once a stock has fallen 10 percent from the previous day’s closing price. Short sellers sell borrowed securities, hoping to buy them later at a lower price and return them to the lender.
Imposing volatility-based pauses on markets dominated by electronic trading is a “can of worms,” said Tim Quast, founder and managing director at ModernNetworks IR LLC. He said he’d prefer a broader set of rule changes that reduce the emphasis on speed in trading.
“Exchanges get revenue streams from data and transactions,” he said. So markets with clear controls on price movements can try to preserve their share of trading and get more high-frequency trading within a narrower price range.”
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