WASHINGTON, D.C. -- On the one-year anniversary of the Flash Crash, Securities and Exchange Commission chairman Mary L. Schapiro said the behavior of high-frequency trading firms will be closely scrutinized -- and placing obligations on high-speed traders to maintain markets in stocks "remains on the table.''
The disappearance of high-frequency traders at critical moments of the Flash Crash means that regulators must "thoroughly examine their role" in exacerbating the plunge instead of correcting it, Schapiro said to attendees of the General Membership Meeting of the Investment Company Institute.
While the findings last October of the SEC and the Commodity Futures Trading Commission did not cite high-frequency trading as a cause of the crash, Schapiro noted Friday morning that high frequency trading accounted for 50 percent of volume in that volatile day -- and that high frequency traders were "net aggressive sellers in the decline.''
"Tremendous harm was done that day,'' she said and that this was due to a "technical market structure problem,'' not any fundamental change in investing conditions or economic prospects.
Fundamental investors, in fact, she said, would have been strong buyers in the decline, when prices plunged 600 points in five minutes.
But high-frequency traders did not act like fundamental investors -- or market makers.
She compared the behavior of high frequency traders, whom she called the de facto market makers on May 6, 2010, to that of trading floor specialists, the market makers of the time on May 28, 1962, when a similar Flash Crash occurred.
In both cases, systems were overwhelmed by sell orders and created a sudden decline that struck at investor confidence.
The specialists, who accounted for 17% of volume, were net buyers in the decline. The crash took out 6.3% of the value of stocks, at its max.
This time around, high frequency traders either pulled back or pulled out. They accounted for 50 percent of volume and responded to what already was a down day "by taking liquidity rather than provide it,'' she said.
Such "net aggressive" selling needs to be curbed, to prevent future recurrences. She is recommending that circuit breakers on stocks -- which now apply to 1,000 equities and about 300 exchange-traded funds -- be made tighter.
Right now, the breakers take effect when prices surge or drop 10 percent in a five-minute period. She wants that trigger turned down to 5 percent. That would have caught prevented a crash in 84 percent of the stocks and 98 percent of the trades that were involved in the May 6 Flash Crash, she said.
But she also said that the commission will continue to look at what kind of market-making obligations to put on high-frequency traders.
These need to be constructed in such a fashion as to not be unfair to different trading firms and market participants.
But she said the commission also will be looking at constructing an "entire regulatory structure" around high frequency traders and the algorithms they use to execute buy and sell orders in electronic markets. She said regulators will need to be sure those algorithms "operate correctly in stressed market conditions."
She said limits could be placed on algorithms, to prevent "nonfundamental runs" on stocks.
She also said she believed that exchanges, alternative trading systems, clearing firms, depositories and securities information processors should face a mandatory annual review of their automation, to make sure their systems are "sufficiently robust" to handle peaks and flows of markets, even on extremely volatile days.
Such as one year ago today, when the Dow Jones Industrial Average dropped 998 points or 9.3% at its worst point. And where 600 of those points were lost and came back in a matter of minutes.
Here's a look back at the Flash Crash of May 6, 2010.
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