SEC Approves Two Pilot Programs to Address Market Volatility
By Cydney Posner
On Thursday, the SEC approved, for a one-year pilot period, two proposals submitted by FINRA and the national securities exchanges designed to address market volatility. The exchanges and FINRA will implement these changes by February 4, 2013.
The first initiative, originally proposed by FINRA in April 2011 (see my article of 4/5/11), establishes a "limit up-limit down" mechanism intended to prevent trades in individual exchange-listed stocks from occurring outside of specified price bands. The price bands would be set at percentage levels above and below the average price of each security over the immediately preceding five-minute period. For more liquid securities — those in the S&P 500 Index, Russell 1000 Index, and certain exchange-traded products — the level will be 5% and, for other listed securities, the level will be 10%. The percentages will be doubled during the opening and closing periods, and broader price bands will apply to securities priced at or below $3 per share. To accommodate more fundamental price moves, these limit up-limit down requirements would be coupled with five-minute trading pauses, similar to the pauses triggered by the current circuit breakers, if trading cannot occur within the price band for more than 15 seconds. The new mechanism is designed to replace the existing single-stock circuit breakers, which, while considered effective in moderating volatility, could be triggered inappropriately by erroneous trades. As a result, the exchanges and FINRA focused on developing a more sophisticated mechanism that could avoid that problem.
The second initiative, originally proposed by FINRA in September 2011 (see my article of 9/27/11), updates existing market-wide circuit breakers that are designed to halt trading in all exchange-listed securities throughout the U.S. markets when the designated percentage-decline threshold is crossed. http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf The current market-wide circuit breakers have been triggered only once since their adoption in 1988 and were not even triggered during the severe market disruption of May 6, 2010. To address that issue, the update lowers the percentage-decline threshold for triggering a market-wide trading halt, reduces the amount of time that trading is halted and implements other changes as follows:
- Reduces the market decline percentage thresholds needed to trigger a circuit breaker to 7%, 13% and 20% from the prior day's closing price, rather than the current decline thresholds of 10%, 20% or 30%.
- Shortens the duration of trading halts that do not close the market for the day to 15 minutes, from 30, 60 or 120 minutes.
- Simplifies the structure of the circuit breakers to provide only two relevant trigger time periods, those that occur before 3:25 p.m. and those that occur on or after 3:25 p.m. The two periods replace the current six-period structure.
- Uses the broader S&P 500 Index, rather than the DJIA, as the pricing reference to measure a market decline.
- Requires the trigger thresholds to be recalculated daily rather than quarterly.