Download Review of the Market Events of May 6, 2010

Review of the Market Events
of May 6, 2010
September 2010
Table of Contents
1.0
Introduction ....................................................................................................... 1
2.0
Executive Summary ............................................................................................ 1
3.0
Event Overview .................................................................................................. 8
4.0
Analysis and Findings ....................................................................................... 12
5.0
Next Steps ........................................................................................................ 23
1.0
Introduction
This report summarizes a review of the equity market events in the Canadian
marketplace on May 6, 2010. This review was undertaken to better understand the
causes of the sudden price declines and recoveries in the afternoon of May 6 in the
Canadian marketplace in conjunction with similar events in the US and to inform
decisions about the necessary steps to avoid or mitigate a recurrence.
The review of the events behind the “Flash Crash” of May 6 was an undertaking
involving the reconstruction of one day of trading across 9 marketplaces during an
extremely active trading day and involving thousands of securities and over 230 million
data points. This report represents the summary of IIROC’s findings and observations.
2.0
Executive Summary
On May 6, 2010, the North American financial markets experienced a brief but very
severe drop in prices, falling more than 5% in a matter of minutes.
The market
recovered a very short time later. Since that day, IIROC has collected and reviewed
large amounts of data in order to understand the events and to recommend
appropriate measures for the future.
In the US markets the Dow Jones Industrial Average (DJIA) had dropped by 245 points
by 2:30 pm from the previous closing level. Shortly after 2:30 pm, the market decline
steepened and suddenly dropped to 9,873.57 at 2:47 pm, a total of 9.16% decline
from the previous day's close. As quickly as the market dropped, it suddenly and
dramatically reversed itself and ended the day at 10,520.32, down a total of 347.80, or
3.20%, from the prior day's close. The trading that occurred during the dramatic price
declines from 2:40 pm to 3:00 pm affected a large number of securities and some
traded as low as one cent. These securities recovered and generally closed much closer
to their opening price for the day. A broad number of securities were impacted in the
1
US including many highly liquid securities and Exchange Traded Funds (ETF). This had
a profound impact on the DJIA.
In Canada the markets were as volatile as the US and the market volumes had been
increasing for several days. The TSX market opened with the S&P/TSX Composite
Index (TSX Composite) at 11,845 points (down 30 points from the previous day’s
close) and slowly declined during the morning trading. By 2:30 pm the Index had
declined to 11,728 (down 147 points, or 1.24%, from the previous close). Between
2:30 pm and 2:50 pm the TSX Composite fell a further 306 points, for a total decline of
453 points or 3.8% from the previous day’s close. As quickly as the market fell it
reversed itself and closed at 11,842 points for a daily decline of 0.2%. The TSXV market
declined during the morning trading and at 2:30 pm to 3:00 pm the S&P/TSXV
Composite Index fell by 40 points, or 2.5% and then reversed itself to close at 1,562
points for a daily decline of 35 points or 2.1%. Trading prices on the Alternative
Trading Systems (ATS) generally followed the TSX and TSXV showing the same market
decline and rebound as that on the listed markets. This correlation is not surprising
due to the full depth of book price protection obligation in the Canadian market.
Trading on the Canadian National Stock Exchange (CNSX) did not appear to be
affected by the turmoil on the other markets and there were no trades executed in that
market in the period 2:30 pm to 3:00 pm.
The decline in the Canadian indices lagged approximately two minutes behind the US.
In addition, the decline on the Canadian indices was neither as steep nor pronounced
as that in the US markets. By the time the Canadian indices were in decline, the US
indices had already started to recover, and the Canadian indices followed suit very
quickly.
A total of 8.5% of TSX-listed securities and 13.8% of TSXV-listed securities experienced
a 10% or greater drop in price based on a comparison between the May 5, 2010
closing price and the lowest trading price on May 6, 2010. This drop in prices was of a
2
lesser magnitude on the Canadian market than the drop that was experienced on the
US market and fewer securities were affected.
IIROC surveillance staff made trade rulings affecting four different securities that
experienced particularly egregious trade prices that were identified late on May 6,
2010. In addition to these, one ruling affecting a fifth issuer was made on May 13,
2010. All of the rulings followed the Market Surveillance policies and procedures
which set out the requirements and considerations for staff rulings under the authority
of UMIR 10.9 (1).
After May 6, IIROC initiated a full review of the trading across all marketplaces to
identify the securities that exhibited the most egregious price movements.
A total of 47 securities were investigated in detail as these securities exhibited more
than a 20% drop in price from their previous day’s closing price with most of the
decline occurring between approximately 2:45 pm and 3:00 pm. All securities showed
precipitous declines varying in severity. The price decline for each security was very
rapid, with some stocks falling 10% in less than one second and the price recovery was
also very quick.
IIROC’s review shows that the Canadian marketplaces reacted rapidly to the US decline.
There is no evidence of erroneous orders, computer glitches or any futures or options
trading that spurred the decline in the Canadian marketplace. While factors were
identified as having influenced the behaviour of the securities reviewed, none of the
securities reviewed exhibited all the identified factors. The factors that contributed to
the trading patterns are:
•
The existence of large sell imbalances: A number of the securities showed more
sell interest beginning at the opening of trading on May 6 and in some cases the
ratio of sell volume to buy volume was upwards of 3:1. The concerns over
many world events which were causing anxiety in the marketplaces suggest that
it was natural for there to be selling pressure in the market. The presence of
3
such a strong liquidity imbalance put downward pressure on all of the securities
and most of the stocks showed evidence of price declines in the morning and
early afternoon.
•
Electronic trading activity in the securities: High Frequency Traders (“HFT”) and
Electronic Liquidity Providers (“ELP”) were trading in a number of the securities
reviewed. Although the definitions of the above terms are open to discussion,
we are using these terms to identify fast and relatively dominant electronic
traders. The review shows that after the sudden sharp decline in the US indices,
a number of HFTs and ELPs quickly withdrew from the Canadian market causing
a dramatic and rapid decline in available liquidity.
This withdrawal was
particularly apparent on the buy side putting further pressure on prices. Some
HFT entities remained in the market but predominately on the sell side and we
noted markedly reduced liquidity.
The withdrawal of HFTs and ELPs was
particularly apparent in the heavily traded ETFs that were reviewed. IIROC is
aware that some of the ELP and HFTs withdrew from the US market due to their
concern about significant latencies in their data feeds from the US markets.
•
“Traditional” market makers were not active in the review securities with the
exception of the four highly liquid ETFs. IIROC found that market makers were
present and fulfilling their obligations on the other securities reviewed including
their oddlot and spread goals. The speed of the decline on May 6 and the
realities of the new fast-paced multi-market environment underscores the
challenges faced by traditional market makers in effectively discharging their
responsibilities to maintain a two-sided market during this time. While some
market participants and commentators have suggested that HFTs and ELPs serve
a quasi market maker role, this study indicates that the majority of these
participants withdrew from the market on May 6 during the rapid price declines.
•
The triggering of Stop Loss Orders: In many cases the triggering of Stop Loss
Orders was a major contributor to the deeper price declines experienced by a
4
number of the securities reviewed.
The analysis suggests that many of the
egregious price declines were due to Stop Loss Order activity from Stop Loss
“market” Orders as opposed to Stop Loss “limit” Orders.
Volatility controls at the marketplace level were triggered on May 6 on the three
markets (TSX, Alpha ATS, and Pure Trading (CNSX)) that had the controls. It was noted
that these controls were all different and not coordinated. Trading freezes or reject
parameters are triggered by a single order which, if executed, would result in a trade at
prices outside of set parameters. These mechanisms are not generally designed to slow
down or impede price changes but are rather designed to prevent trades resulting from
erroneous order entry. Some of the review securities experienced TSX freezes, Alpha
order rejects and Pure order rejects, including four of the five securities on which IIROC
ruled. However, it does not appear, based on the review, that these controls were
effectual in slowing or stemming the price declines.
In addition, they were not
coordinated and were not present at all the markets. Finally, it was noted that in some
cases these volatility controls were triggered as stock prices began to recover.
There is no evidence of a large scale migration of liquidity to other Canadian
marketplaces occurring as the result of the freezes on the listed markets or rejections by
the ATSs. However, it is clear that some orders did migrate to other marketplaces once
rejected by markets with volatility controls.
Unlike the US “top of book” trade through obligation, the trade through rule in Canada
requires “full depth of book” protection. As a result, price dislocation was not as
significant in Canada as all available liquidity at a price had to be displaced before
prices could move to the next level. In the US, once the “top of book” obligation has
been met, orders are permitted to trade at any price on any market, which contributed
to the large order and price movements witnessed in that market on May 6.
IIROC tested whether the activity seen in the securities would have triggered the SEC
circuit breaker levels set at 10% price drop in 5 minutes. This review shows that 64% of
the review securities would likely have triggered a circuit breaker as implemented by
5
the SEC between 2:30 pm and 2:15 pm on May 6. In the majority of the cases the
circuit breakers would have triggered before the low price of the day was reached.
Several conclusions have been reached as a result of this review and recommendations
have been proposed. However, IIROC believes that these recommendations cannot be
dealt with in isolation but rather must be reviewed together in order to more effectively
address the issues identified by the events of May 6.
1. The trading on May 6 demonstrated that aberrant or volatile trading in one
jurisdiction can easily and very quickly spread to other jurisdictions.
Recommendation: The Canadian Securities Administrators (“CSA”) and IIROC
should review the current market wide circuit breaker to determine if the current
trigger levels are appropriate and whether an independent Canadian-based
circuit breaker level should be considered.
2. The use of automated trading has increased the speed of trading, which has also
increased the speed at which market prices and volumes change and has
dramatically increased the amount of market data.
Recommendation: IIROC along with the CSA should investigate whether single
stock circuit breakers in the form of temporary trading halts should be
implemented in Canada.
3. The current price volatility controls on market trading at the market level do not
work as effectively as they should in a multi-market environment.
Recommendation: All Canadian marketplaces should adopt volatility controls
and the form and the level of these controls should be reviewed to assess to
what degree they ought to be harmonized.
4. The use of Stop Loss Orders without limits, (i.e. Stop Loss “market” Orders) can
have a very detrimental impact on investors in volatile markets and should be
used with caution.
6
Recommendation: All IIROC dealers should consider how to effectively manage
Stop Loss Orders in the current high-speed, multi-market environment. IIROC
firms should also provide their RRs and clients, including those who enter their
orders directly on to the marketplace without personalized advice, with
guidance on the use of Stop Loss Orders effectively in a high speed, multimarket environment.
5. The events surrounding May 6, 2010 have underscored that the procedures
surrounding the cancellation and re-pricing of trades should be reassessed and
made more transparent so all market participants understand the process and
the controls on this surveillance activity.
Recommendation: IIROC
should
review
the
current
erroneous
and
unreasonable price policies and procedures, taking into account the experience
of May 6, 2010 and will publish them for comment.
7
3.0
Event Overview
On Thursday May 6, 2010 the North American markets had spent much of the morning
and early afternoon in moderately negative territory.
The DJIA had declined 161
points, or approximately 1.5 percent, by 2:00 pm (EST). Concerns over the financial
situation in Greece, the uncertainty concerning elections in the United Kingdom, an
upcoming jobs report, and other economic factors hung over the markets in North
America. In addition, the Canadian markets had been volatile and the TSX Composite
had declined in the few days preceding May 6.
Between 2:30 pm to 3:00 pm in the afternoon of May 6, the North American financial
markets experienced a brief but very severe drop in prices in many securities with many
equity market indices falling more than 5% in a matter of minutes. The recovery in
prices was almost immediate; however, this sudden drop left a trail of poorly priced
trades and shook confidence in the markets.
3.1
Canadian Markets
In Canada the markets were as volatile as the US and the market volumes had been
increasing for several days. The TSX market opened with the S&P/TSX Composite
Index (TSX Composite) at 11,845 points (down 30 points from the previous day’s
close) and slowly declined during the morning trading. By 2:30 pm the Index had
declined to 11,728 (down 147 points, or 1.24%, from the previous close). Between
2:30 pm and 2:50 pm the TSX Composite fell a further 306 points, for a total decline of
453 points or 3.8% from the previous day’s close. As quickly as the market fell it
reversed itself and closed at 11,842 points for a daily decline of 0.2%. On the TSXV
market prices slowly declined during the morning. Between 2:30 pm to 3:00 pm the
S&P/TSXV Composite Index fell by 40 points, or 2.5% and then reversed itself to close
at 1,562 points, for a daily decline of 35 points or 2.1%.
8
Trading on CNSX did not appear to be affected by the turmoil on the other markets.
No unusual activity was noted and trading was well within the normal levels. There
were no trades between 2:30 pm and 3:00 pm.
Trading prices on the ATSs generally followed the TSX and TSXV prices as a result of
the order routing and the best price rule. The ATS marketplaces showed the same
price declines and recoveries as those on the TSX and the TSXV markets.
A total of 8.5% of TSX-listed securities and 13.8% of TSXV-listed securities
demonstrated a 10% or greater drop in price based on a comparison between the May
5, 2010 closing price and the lowest trading price on May 6, 2010. This drop in prices
was of a lesser magnitude and affected fewer securities on Canadian marketplaces than
was experienced on the US markets.
As a result of the trading on May 6, IIROC ruled on 223 trades. All of the rulings
followed the Market Surveillance policies and procedures which set out the
requirements and considerations for staff rulings under the authority of UMIR 10.9 (1).
These include who is empowered to make rulings, the steps which must be followed to
determine whether a trade price is reasonable or unreasonable, factors which should
be taken into consideration and the circumstances under which staff may stray from
the established guidelines.
In addition, the procedures provide guidance on the
amount of time following a trade that a ruling may be made and the circumstances
under which a public announcement of such rulings must be made.
3.2
US Markets
In the US markets just prior to 2:30 pm the DJIA had dropped 239 points since the
open at 9:30 am and had lost 245 points from the previous day’s closing level. Shortly
after 2:30 pm, the market price decline began to steepen and by 2:42 pm the DJIA was
10,445.84 points, a decline of approximately 3.9% since the market opened. The DJIA
then suddenly fell an additional 573.27 points (-5.49%) over the next five minutes of
9
trading to 9,872.57 points by 2:47 pm. The DJIA had dropped a total of 9.16% from
the previous day's close.
As quickly as the market dropped, it suddenly and dramatically reversed itself,
recovering 543 points in approximately a minute and a half, to 10,415.65 points. By
3:00 pm, the total daily decline in the DJIA had been reduced to 463.05 points or
4.26%. The DJIA ended the day at 10,520.32, down 347.80 points or 3.20%, from the
prior day's close.
Over the short period of this dramatic price decline and subsequent recovery, many
trades had executed from 2:40 pm to 3:00 pm. A broad number of securities were
affected and some high priced securities traded as low as one cent.
3.3
Analytical Review
An analytical review was undertaken to determine what specifically happened in the
market on May 6 and to define what factors led to the rapid price declines on that day.
The preliminary reviews of the market events in the US have been released by both the
SEC and the CFTC, and identify specific factors that may have led to the extreme price
changes. IIROC’s review summarizes the factors that were at play in the Canadian
market and also identifies areas of similarities and differences with the US findings.
The trading of all TSX-listed and TSXV-listed securities was reviewed to identify the
securities which demonstrated the most unusual price movement for further in-depth
1
review .
1
Two different types of analysis were used to identify the securities that were most affected by events on
that day including Price Movement and Alert Analysis. Price Movement was defined as the low price on
May 6 minus the closing price on May 5 divided by the May 5 closing price. Market data from all
marketplaces was used for this process. Alert Analysis involves the identification of alerts generated by
IIROC’s surveillance systems including alerts to monitor price movement, trade rate, and order rate. 10
Based on the analysis conducted IIROC identified 47 securities (“the review securities”)
for in-depth review. IIROC focussed the in-depth review on the stocks that:
•
demonstrated a 20% or greater drop in price or an alert reflecting a 20% drop in
the relevant period on May 6, 2010;
•
had liquidity of greater than 10 trades per day;
•
traded at a price of greater than $0.10; and,
•
included the five stocks on which IIROC made rulings.
The 47 securities were reviewed in-depth.
The following attributes were noted
regarding these 47 securities:
•
26, or 55%, of the review securities were highly liquid;
•
9, or 19%, of the review securities were inter-listed;
•
18, or 38%, of the review securities were subject to a freeze on the TSX on May
6, 2010;
•
10, or 21%, of the review securities had orders rejected by Alpha pursuant to
their price volatility parameters;
•
9, or 19%, of the review securities were subject to a freeze on Pure;
•
8, or 17%, of the review securities were ETFs;
•
18, or 38%, of the review securities were Index constituents (on a variety of
S&P/TSX or S&P/TSXV indices);
•
13, or 28%, of the review securities were underlying to Montreal Exchange listed
options.
11
The sector makeup of the 47 securities is:
Sector
Clean Technology/Income Trust
Diversified Industries
ETF
Financial Services
Forest Products
Major Airlines
Mining
Oil &Gas
Pulp & Paper Products
Real Estate
Structured Products
Technology
Utilities & Pipelines
4.0
Total
1
6
8
1
2
2
7
8
1
5
2
1
4
Analysis and Findings
The analysis indicates that the rapid price decline in many of the review securities was
the result of many factors. Most significantly, the decline experienced by many of the
review securities was a direct reaction to events occurring on the US markets which
caused many of the more active traders to withdraw from the market and to cause a
sudden lack of liquidity.
4.1
Canadian Indices versus US Indices
A comparison of the behaviour of the US DJIA and S&P500 Index versus the Canadian
S&P/TSX60 and S&P/TSX Composite Indices reveals that the decline in the Canadian
indices lagged approximately two minutes behind the US indices and that the decline
of Canadian indices was of a lesser magnitude than the decline of US indices. Further,
the recovery in Canada started after the US markets had begun to recover.
The
following chart shows the performance of the four indices on a relative scale for the
period between 2:00 pm and 3:00 pm.
12
Relative Index Levels 2:00 p.m. = 100%
101.00%
100.00%
99.00%
98.00%
97.00%
96.00%
95.00%
94.00%
93.00%
14:00
14:01
14:02
14:03
14:04
14:05
14:06
14:07
14:08
14:09
14:10
14:11
14:12
14:13
14:14
14:15
14:16
14:17
14:18
14:19
14:20
14:21
14:22
14:23
14:24
14:25
14:26
14:27
14:28
14:29
14:30
14:31
14:32
14:33
14:34
14:35
14:36
14:37
14:38
14:39
14:40
14:41
14:42
14:43
14:44
14:45
14:46
14:47
14:48
14:49
14:50
14:51
14:52
14:53
14:54
14:55
14:56
14:57
14:58
14:59
15:00
92.00%
5/6/2010
S&P/TSX Composite
S&P/TSX 60
DJIA
S&P 500
The review shows that in the Canadian market the sudden price declines began at
approximately 2:45:30 pm, approximately two minutes after the DJIA and the S&P500
experienced their initial large drop. By 2:45 pm the DJIA had fallen 2% in the previous
three minutes and the S&P500 had fallen 3% in the previous four minutes.
All
securities reviewed then fell rapidly, with some extremely significant price declines
occurring in less than one second. The Canadian market did not fall as significantly as
the US did. The recovery in Canada was as rapid as the US recovery and the TSX index
closed within 0.2% of the index at the open.
4.2
The Performance of the Securities Prior to the Disruption The global economic outlook was affecting confidence in the markets around May 6,
2010 and there was pressure on stock prices.
A number of the securities had
demonstrated a sell imbalance at the opening of trading on May 6, 2010 and in some
cases the number of shares offered was 3 to 4 times the volume offered on the bid.
Most of the markets experienced a gradual, sometimes steady decline in the morning
13
and early afternoon. At approximately 2:20 pm the rate of price decline in many of the
review securities accelerated. The comparison of the US and Canadian indices revealed
that the US indices experienced an initial tremor at approximately 14:20.
4.3
Factors Driving the Rapid Decline in Certain Securities on May 6, 2010
A number of key factors affected the trading in the securities reviewed. However, not
all of the contributing factors were common to each of the securities reviewed. Four
key factors were identified including:
1. Most of the securities demonstrated a strong sell imbalance at the opening of
trading on May 6, 2010. In some cases, the number of shares offered was 3 or 4
times that on the bid.
For the most part, prices in the securities reviewed
experienced a gradual, sometimes steady, decline in the morning.
At
approximately 2:20 pm price declines became sharper and deeper and buy
interest waned as sell interest increased. At approximately 2:45 pm there was an
increased sudden and dramatic price decline.
2. Electronic traders including HFT and ELP were active in many of the review
securities. The review shows that after the sudden sharp decline in the US
indices, a number of HFT and ELP traders quickly withdrew from trading in the
Canadian market causing a dramatic and rapid decline in available liquidity.
(IIROC is aware that some of the ELPs and HFTs withdrew from the US market
due to their concern about significant latencies in their data feeds from the US
markets.) This withdrawal was particularly apparent on the buy side. Some HFT
entities did remain actively trading in the market but remained predominately
on the sell side with much less activity. HFT and ELP entities were particularly
active in four of the ETFs reviewed as they were highly liquid securities. All four
ETFs reviewed experienced a sudden withdrawal of liquidity resulting in sharp
and rapid price declines which were then followed by an equally sharp and
rapid price recovery.
14
3. “Traditional” market makers were not active in the review securities with the
exception of the four highly liquid ETFs. IIROC found that market makers were
present and fulfilling their obligations on the other securities reviewed including
their oddlot and spread goals. The speed of the decline on May 6 and the
realities of the new fast-paced multi-market environment underscores the
challenges faced by traditional market makers in effectively discharging their
responsibilities to maintain a two-sided market during this time. While some
market participants and commentators have suggested that HFTs and ELPs serve
a quasi market maker role, this study indicates that the majority of these
participants withdrew from the market on May 6 during the rapid price declines.
4. The triggering of Stop Loss Orders was a major contributor to the deepest price
declines experienced by a number of the review securities.
While some
securities experienced orderly price declines due to their very liquid depth of
order books, many of the less liquid securities suffered deep price drops as the
execution of these Stop Loss Orders generated the triggering of deeper priced
Stop Loss Orders. Most of these egregious price dislocations experienced on
May 6 involved Stop Loss “market” Orders rather than Stop Loss “limit” Orders.
IIROC’s analysis shows that these Stop Loss Orders were generally entered in the
marketplace prior to the events of May 6. Stop Loss Orders that were entered
into a marketplace are booked as limit orders once triggered and result in either
being fully filled, partially filled with the remainder booked at the trigger price,
or booked with no immediate fill. Dealers can also actively manage Stop Loss
Orders internally once they are triggered and booked and may re-price the
orders, either manually or using an automated system, based on the client’s
original instructions. On May 6 multiple market Stop Loss Orders were repriced, many in succession, which then traded down through the depth of book
until either the order was fully executed or the book was exhausted of all
liquidity, leaving partially filled sell orders at limit prices below the lowest depth
price point of the security at that time (some down to a penny). These low
15
priced market Stop Loss Orders, now limit orders, remained in the book. As buy
liquidity returned, the orders were filled at these low offer prices, until the Stop
Loss Orders were satisfied. This activity resulted in dramatic price declines in
some securities.
4.4
Volatility and Erroneous Trade Mechanisms at the Marketplaces
During the trading on May 6 the volatility and erroneous trade controls at three of the
market centres were activated.
Trading freezes or erroneous trade reject mechanisms at the marketplace level are not
in place to slow down or impede price changes. Rather, they are designed to prevent
trades resulting from erroneous order entry. In many cases, significant stock price
changes may occur in a series of trades over a short period of time without triggering a
stock freeze or reject.
However, freezes and rejects will occur as the stock price
changes in large steps in an illiquid book.
Trading freezes are not considered
regulatory halts. Rather, they are business halts implemented at the discretion of the
marketplace. There is no coordination across marketplaces of trading freezes or reject
parameters and trading continues on other marketplaces while there is either a freeze
in effect or a rejected order on a marketplace.
Volatility Controls on the TSX and TSXV
The TSX and TSXV employ two types of volatility controls: bid/ask tick limits and
trading freezes. If a single order is entered that will have the effect of moving the stock
price more than the allowable limit set by the Exchange, the price may either be limited
by the bid/ask tick limit, or trading will be temporarily suspended by the freeze
parameter. Depending on the applicable bid/ask limit or freeze parameter, and the
existing best bid, offer, and last sale, either mechanism, but not both, may be invoked
when an order is entered.
16
If the order entered triggers the freeze parameter, further order entry is inhibited, and
TSX staff will review the circumstances of the order which has caused the freeze, and
decide whether to let the trade proceed or cancel the order which caused the freeze. If
the order appears to be erroneous, TSX staff may contact the firm responsible to
determine if the order is valid. Trading freezes are triggered by a significant price
deviation of a single trade when compared to the previous boardlot trade price. If a
large price movement occurs in stages, for example when a trader walks the price
down incrementally, even when this movement occurs over a very short period of
time, trading may not trigger a freeze.
A total of 18, or 38%, of the review securities were subject to a freeze on the TSX.
Some of the freezes were triggered as the stock began to recover as the result of higher
priced buy orders. The review shows no evidence of a large scale migration of orders
to other Canadian marketplaces as the result of the freezes on the TSX or TSXV in a
manner similar to what occurred on US markets. While some orders did migrate to
other marketplaces, the number was relatively low. The fact that orders did migrate
does highlight the effect of the lack of coordination of trading freeze parameters on
Canadian marketplaces.
It is also important to note the trade through obligation in Canada is a “full depth of
book” obligation. As such, orders in Canada could not bypass any visible, better-priced
orders on other marketplaces and the price decreases were slowed until all liquidity
was exhausted. This should be contrasted with the situation in the US where order
migration from some of the markets that employed volatility controls or experienced
market data issues was significant and the securities traded to increasingly lower levels
without the obligation to trade with all better-priced orders in transparent markets.
Rejected Orders on Alpha
Alpha ATS has implemented an Error Correction policy that uses both dynamic and
static price bands to manage the risk of both a clearly erroneous order or where a series
of subsequent orders would cause trades that should not occur (major price variation).
17
An order (or part of an order) will be rejected if it would participate in a trade where
the price exceeds the lower of the dynamic upper price band and the static upper price
band or the higher of the dynamic lower price band and the static lower price band. A
static price band is based on a percentage comparison to the Alpha Last Sale Price from
15 minutes before the entry of the order. A dynamic price band is based on a
percentage comparison to the Alpha Last Trade Price. These bands can be changed to
reflect market conditions.
Of the review securities, 10, including the five securities which were subject to trade
cancellation and/or re-pricing, had orders which were rejected by the Alpha trading
engine. Of the five securities on which IIROC ruled, three had three or fewer rejected
orders, at prices either above or below current trading prices on recovery.
The
remaining two had a larger number of rejected buy and sell orders, many at prices
below the national low trade price of the day but some at prices in line with the
recovery period. It appears that the Alpha volatility controls deflected orders which
might have contributed to lower prices, and orders which might have contributed to
the recovery of prices. Finally, it was noted on a very few occasions that orders rejected
due to the Alpha volatility bands did migrate to other marketplaces where they were
subsequently executed at prices which contributed to the stock decline.
Freezes on Pure
Pure Trading (CNSX) has a freeze mechanism which triggers as the result of an inbound
order which would generate price movement in a given security which exceeds the
applicable freeze parameters.
Staff at Pure will review the order and determine
whether to allow the trade to occur, or to cancel or allow the cancellation of the order.
Of the review securities, 9 were subject to freezes on Pure.
Other Markets
No other Canadian Exchange or ATS have freeze or reject parameters.
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4.5
ETFs
Eight or 17% of the review securities were ETFs. Three of these were Index ETFs (which
were also Highly Liquid securities) and all were based on US indices. The review of
these three Index ETFs revealed a dominant HFT/ELP and market maker presence in
their trading. Between 2:42 pm and 2:45 pm there was withdrawal by some of the
HFT entities and ELP from the market. This was followed by a sharp and rapid decline
in the price of the security which was then followed by a sharp and rapid recovery.
None of the three experienced a period of disruption past 2:48 pm, which was
considerably shorter than most of the securities reviewed. This is likely due to their tie
to the US Indices which were in recovery by 2:48 pm.
On May 6, the relationship between market price and net asset value of the ETF
decoupled at the onset of the unusual price decline. While ETFs are often used by
professional traders and institutions in conjunction with various derivative and hedging
strategies, ETFs are also a "favoured" investment vehicle of retail investors, particularly
"do-it-yourself" investors.
The triggering of Stop Loss Sell Orders overwhelmed existing buy liquidity causing
further rapid and significant price declines and led to triggering of additional Stop Loss
Orders. In this scenario, the Stop Loss Orders caused the very significant price declines
they were intended to guard against. While the Canadian ETFs did not suffer the same
declines as US ETFs, a number of ETFs were identified as part of the review securities.
4.6
Circuit Breakers
IIROC also undertook a preliminary assessment as to whether the Canadian securities
reviewed would have triggered a circuit breaker such as that proposed by the SEC.
IIROC identified if and when a circuit breaker would have triggered during the relevant
period if the circuit breaker threshold were set at a 10% decline over a 5 minute period.
The results indicated that 30, or 64%, of the review securities would likely have
triggered a circuit breaker in the period between 2:30 pm and 3:15 pm. Further, all of
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the triggers would have resulted from downward movement in the price and would
have triggered before or at the low price of the day.
4.7
IIROC Findings Compared to CFTC/SEC Preliminary Findings
On May 18, the CFTC and SEC issued their “Preliminary Findings Regarding the Market
Events of May 6, 2010” (the “US Report”).
The IIROC preliminary findings are very similar to the findings in the CFTC/SEC
preliminary findings with some notable differences. While some of the same factors
contributed to both the US and Canadian rapid price declines, the Canadian price
decline followed rapidly dropping prices in the US. Each of the US “possible” factors is
compared to the Canadian findings.
1. 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;
•
It is clear that the Canadian markets reacted rapidly to the US decline.
There is no evidence of any erroneous orders, computer glitches or any
futures or options trading that spurred the decline in the Canadian
marketplace.
Trading records clearly show that the Canadian prices
began to decline approximately two minutes after US markets started
falling and was a reaction to the trading in the US markets.
2. A generalized severe mismatch in liquidity, as evidenced 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;
•
IIROC’s review revealed a mismatch of liquidity.
Most of the review
securities had exhibited a dominance of sell liquidity from the opening of
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trading on May 6.
Further, while not consistent across all securities
reviewed, the withdrawal of liquidity by HFTs was noted. It is also evident
from IIROC’s review that the Stop Loss Market Orders contributed to the
large price declines seen in a large number of the securities.
3. 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;
•
IIROC’s review has shown no evidence of a large scale migration of orders
to other Canadian marketplaces as a result of trading freezes on the TSX,
TSXV, and Pure or price volatility rejects on Alpha. While some orders did
migrate to other marketplaces, the levels were relatively low. To the
extent that migration did occur, however, it highlights the absence of
coordination of marketplace level volatility controls in Canada.
4. 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;
•
US-style “stub quotes” are an automated feature offered by the US
markets to assist market makers in maintaining their two-sided market
obligation. As a result, stub quotes exist for a significant number of US
securities and many of these quotes are far outside the current bid and
ask.
A US-style stub quote feature is not offered by any Canadian
marketplace. While Canadian markets do contain bids and offers which
are far outside the current bid and ask, they are not automated and they
are not as pervasive across all classes of securities as US stub quotes.
There is no evidence that such Canadian orders contributed to the price
declines on May 6, 2010.
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5. 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;
•
There is strong evidence that the use of Stop Loss Orders and, in
particular, Stop Loss “market” Orders were a contributing factor to the
rapid and steep decline of a number of the securities reviewed.
6. The impact on Exchange Traded Funds (ETFs), which suffered a disproportionate
number of broken trades relative to other securities.
•
The US Report noted that a large percentage of the May 6 trades which
were cancelled (based on the 60% criteria) were ETFs. IIROC ruled on
only two ETFs. A total of eight, or 17% of the review securities are ETFs.
Four of these are Index ETFs; three of the four are based on US indices and
are also Highly Liquid Securities. The review of these three Index ETFs
revealed a dominant HFT/ELP and market maker presence in their trading.
Several of the HFTs left the market on May 6. The triggering of Stop Loss
Sell Orders also impacted the price declines in these instruments.
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5.0
Recommendations and Next Steps
Several conclusions have been reached as a result of this review and recommendations
have been identified. However, IIROC believes that these recommendations cannot be
dealt with in isolation but rather must be reviewed together in order to address the
issues raised by the events of May 6.
1. The trading on May 6 demonstrated that aberrant or volatile trading on one
market can easily and very quickly spread to other markets.
Recommendation: The CSA and IIROC should review the current market wide
circuit breaker to determine if the current trigger levels are appropriate and
whether an independent Canadian-based circuit breaker level is required.
Next Steps: Work on this initiative has not yet commenced.
As the North
American financial markets are very interconnected and the current market wide
circuit breakers are based on those in the US which, in turn, are under review,
IIROC will work with the CSA and will consult with both Canadian marketplace
participants and US regulators on this issue.
2. The use of automated trading has increased the speed of trading, which has also
increased the speed at which market prices and volumes change and has
dramatically increased the speed and the amount of market data.
Recommendation: IIROC along with the CSA should investigate whether single
stock circuit breakers in the form of temporary trading halts should be
implemented in Canada.
Next Steps: This initiative is currently underway and IIROC will soon be issuing
a request for comments on a single stock circuit breaker proposal.
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3. The current price volatility controls on market trading at the market level do not
work as effectively as they should in a multi-market environment.
Recommendation: All marketplaces should adopt volatility controls and the
form and the level of these controls should be reviewed to assess to what
degree they ought to be harmonized.
Next Steps:
The CSA and IIROC are currently examining the next steps with
respect to volatility controls in the context of an electronic trading rule and will
recommend an appropriate course of action.
4. The use of Stop Loss Orders without limits, (i.e. stop loss “market” orders) can
have a very detrimental impact on investors in volatile markets and should be
used with caution.
Recommendation: All IIROC dealers should consider how to effectively manage
Stop Loss Orders in the current high-speed, multi-market environment. IIROC
firms should also provide their RRs and clients, including those who enter their
orders directly on to the marketplace without personalized advice, with
guidance on the use of Stop Loss Orders effectively in a high speed, multimarket environment.
Next Steps: IIROC will issue guidance to dealer members and investors on the
appropriate use of certain order types in a multimarket environment.
In
addition, IIROC is currently planning an educational seminar for investors and
interested market participants to help them understand the challenges of trading
effectively in the new market environment.
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5. The events surrounding May 6, 2010 have underscored that the procedures
surrounding the cancellation and re-pricing of trades should be reviewed and
also made more transparent so that all market participants understand the
process and the controls on this surveillance activity.
Recommendation: IIROC
should
review
the
current
erroneous
and
unreasonable price policies and procedures, taking into account the experience
of May 6.
Next Steps: This review is underway and will be published for comment when
completed.
The publication of this review for comment reinforces IIROC’s
commitment to ensuring that its decision-making process with respect to
erroneous and unreasonable trades is transparent to all market participants.
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