'Flash crash' shows need for price discovery and safeguards
Reprinted with permission from Financial Times, 27 May 2010
Around the world, financial markets are giving investors a bumpy ride. The sudden swoon of US stocks on May 6 - now referred to as the "flash crash" - was followed, 10 days later, by huge drops in Shanghai and Hong Kong. With continued nervousness about Europe's fiscal situation, civil unrest in Thailand, fears of conflict in Korea, and the unprecedented oil spill in the Gulf of Mexico, global markets have been hit with a string of bad news recently.
In the US, however, it appears the sharp collapse of a handful of stock prices was due more to weaknesses in the structure and mechanics of our market system than any particular piece of economic news. The Securities and Exchange Commission acted quickly to put in place mechanisms that slow trading down during periods of extreme volatility. These rules will not only apply to the New York Stock Exchange, where similar procedures have been in place for a long time, but to the broad array of electronic exchanges that make up the US market structure. This is an important first step, but restoring full confidence in US capital markets will take more.
Equity markets in the US remain the largest and most liquid in the world - and during the 2008 crisis seemed to be the only segment of the financial system that functioned unimpaired. Yet in less than 20 minutes on May 6, confidence in that market system was significantly damaged. Hours after the market's wild ride, thousands of trades on electronic exchanges were cancelled on a somewhat arbitrary basis, leaving investors questioning the integrity of the marketplace. What is more, the search for a cause has not revealed specific triggers, but instead highlighted challenges with the fragmented nature of US markets.
In most developed markets, there is one "national" exchange on which public companies can list their stock. In the US, there is more than one listings platform and no fewer than 40 trading venues. Many are insufficiently transparent, and most investors have little knowledge or influence over where their trades are executed.
To build confidence in this fragmented system, we must enhance transparency, price discovery and accountability across the marketplace. At the NYSE, we have long believed in the ability to slow our market during times of volatility - analogous to taking the plane off auto pilot during turbulence. However, until recently, no such rules or practices existed at the other trading venues and the other exchanges could legally ignore our established single-stock circuit breakers. The recently announced industry-wide, single-stock circuit breakers are a critical first step to protecting investors from another May 6. Next, we need to focus on transparency and broader market structure issues. Today, more than 30 per cent of all stock transactions in the US do not occur on regulated exchanges. Dark pools, less regulated trading venues that match anonymous buyers and sellers without displaying prices publicly, and other alternative trading platforms can play an important role by enhancing liquidity for certain investors, but these benefits come at the cost of less overall transparency and price discovery across the marketplace.
Here, too, we are encouraged that the SEC is showing strong leadership. Last autumn, in fact, the Commission proposed several regulatory changes in order to "prevent the development of a two-tiered market in access to pricing information".
The lesson from May 6 is clear: price discovery and investor safeguards are absolutely critical elements of market structure, particularly in the face of severe volatility. This is true for traders and investors throughout the world. In Shanghai and Hong Kong, where I visited exchanges and met business leaders last week, thriving financial exchanges represent the cornerstone of capital markets in one of the world's most dynamic and fastest growing regions.
Asian exchanges are undergoing explosive growth to meet demand for capital from entrepreneurs seeking to launch or grow their companies. In China there is huge appetite to be part of the global market place, and the growing strength of exchanges in Asia can help spread the democratisation of capitalism. Pricing companies and exchanging shares in an open, secure, and legitimate fashion helps investors in emerging nations build trust in a market economy.
That is why the steps US exchanges have taken last week to install new stock-by-stock circuit breakers are a critical step. The next step is to continue pushing for more transparent price discovery in the US, and then bring those same safeguards and assurances to marketplaces around the world. By making transparency and investor protection key priorities, we will show how financial exchanges can continue to win investor confidence in all market conditions.
About Duncan Niederauer
Duncan L. Niederauer is Chief Executive Officer of NYSE Euronext. He is a member of the company’s Management Committee and alsoserves on the Board of Directors. Prior to his current position, Mr. Niederauer was head of U.S. cash equities.Before joining NYSE Euronext in April 2007, he was Managing Director and co-Head of the Equities Division Execution Services forGoldman Sachs & Co. He joined Goldman in 1985 and moved to the Equities Division in 1987. In 2000, Mr. Niederauer relocated tothe headquarters of Spear, Leeds & Kellogg, where he managed the firm’s global clearing and execution business. He also ran the EquitiesE-Commerce effort, and was the global head of portfolio trading and spent time in Tokyo in Derivatives and Japanese products.He earned an MBA from Emory University and a BA from Colgate University where he currently serves on the Board of Trustees.