If there is an upside to the Aug. 24, 2015 “flash crash” that saw volatility spike and trigger nearly 1,300 individual trading halts, it is that the asset management industry and the exchanges are now scrambling to work with regulators to prevent a repeat of that infamous day.
“The best thing about it is the coming-together moment for the industry and the regulators,” said Eric Ervin, chief executive of Reality Shares.
Closing in on the one-year anniversary of the shock market disruption that saw 19% of all exchange-traded funds decline by 20% or more, the major interested parties appear eager to do whatever it takes to restore investor confidence.
“Most people would agree that the ETF is not going away, so let's figure out what needs to be done to make it better,” Mr. Ervin said. “After the [Aug. 24] event happened, all the major providers came together and put up a proposal. And we're now starting to see some of those changes take place.”
Among the most significant changes, according to Mr. Ervin, is doing away with some of the rules that trigger trading halts of securities based on preset volatility levels.
The automatic trading halts that kicked in last August have been credited with lighting the fuse that caused the extreme price swings and a
lack of liquidity for some ETFs.
Without a clear idea of where the underlying securities should be priced, market makers that are supposed to provide ETF liquidity essentially stepped back and away from the calamity until the dust settled.
For some financial advisers, who had preset orders to sell when an ETF price dropped below a certain level, the outcome was catastrophic.
Theodore Feight, owner of Creative Financial Design, said his clients lost $5.5 million within three minutes of the Aug. 24 opening bell.
He said the experience not only “shook me to the core,” but Mr. Feight has since sworn off stop-loss orders for ETFs.
In a
December report by the Securities and Exchange Commission, the details of what happened during the flash crash were laid out, but there was still no clear explanation of how it happened, or how it could be prevented in the future.
But the various market participants have since come forth in a show of solidarity to try and fill the gaps that were exposed a year ago.
That solidarity was in full view in a
March 10 letter to the SEC, which was signed by a virtual who's who of the ETF industry, campaigning for revisions to rules related to liquidity and automatic trading halts.
“I think steps have been taken to make the process better, and give investors more confidence,” said Todd Rosenbluth, director of ETF research at S&P Global Market Intelligence.
Mr. Rosenbluth, who recently moderated a panel discussion on the topic of last year's flash crash, cited as an example of the new cooperation in the form of an
announcement from three major exchanges to petition the SEC for some rules revisions.
Bats Global Markets, Nasdaq and the New York Stock Exchange announced last week they plan to file with the SEC a set of exchange rule changes as well as a plan to address extraordinary market volatility.
The exchanges' petition will focus primarily on reducing trading halts by revising the circuit-breaker system that triggers trading pauses.
“One of the positive effects of Aug. 24 was clarification of the rules when trades will and will not be broken if they happened inside (certain preset trading bands),” said Reggie Browne, head of ETF trading at Cantor Fitzgerald.
“Today, there is increased confidence by liquidity providers when to interject into the market,” he added.
David LaValle, U.S. head of the ETF capital markets team at State Street Global Advisors, stressed that Aug. 24 was “an equity market structure event, not an ETF event.”
As a representative of a company with $464 billion worth of ETF assets, Mr. LaValle has a stake in both calming investor nerves about ETF volatility and liquidity, and contributing to improving the system.
“We're actively engaged in conversations with our regulators and the exchanges to enhance changes,” he said. “We're not going to remove volatility from the marketplace, but I'm confident that enough has been changed that we would have a more efficient price discovery process in times of stress in the future.”
Andrew Chanin, chief executive of PureFunds, agreed that revisions are needed to trading-halt rules, but also said Aug. 24 should have taught investors and financial advisers about the risks of using stop-loss orders.
“We saw some ETFs trading down as much as 30%, which is an arbitrage-traders super bowl,” he said. “What we really saw was an incredible arb opportunity for those with some foresight. The lesson is that these types of major swing moves can present investing opportunities.”
