The nation’s stock exchanges and the Financial Industry Regulatory Authority Wednesday filed a proposal with the SEC to establish a new “limit up-limit down” mechanism that would limit swings in stock prices, during periods of volatility.
Under the proposal, trades in listed stocks would have to be executed within a range tied to recent prices for that security.
If approved by the Commission, the new limit up-limit down mechanism would replace the existing single stock circuit breakers, which were approved on a pilot basis shortly after the market events of May 6, 2010.
The collars on trades would be set at a certain percentage above and below the average price of the security over a constantly tracked five-minute period.
For stocks currently subject to the SEC’s circuit breaker program, the percentage would be 5%, and for those not subject to the pilot of that program, now being tested, the percentage would be 10%.
Under the existing circuit breaker pilot, trading in a stock pauses across the U.S. equity markets for a five-minute period if the stock experiences a 10% change in price over the preceding five minutes.
The SEC will seek comment on the proposed plan, which is subject to Commission approval following a 21-day public comment period.
"While I think the circuit breakers are doing a good job, they were implemented pretty quickly and they are working as intended, I think limit-up limit-down would work more effectively,'' Brian Hyndman, senior vice president of Transaction Services for the Nasdaq OMX Group, told a gathering of the Capital Markets Consortium last Fall about the concept.
With a limit-up, limit-down procedure, individual stocks could not trade outside a specified range, say 10 percent, before being forced to pause and let orders replenish themselves and determine a correct price. This kind of price collar would prevent any future events like the May 6 Flash Crash from gaining momentum, he said, avoiding a recurrence.
The pauses also allows, with a brief interruption of 5 seconds or so, trading to continue, said Joe Bracco, a vice president at BATS Exchange, the fourth most active exchange. The limit-up limit-down approach to prices would also prevent broken trades, Hyndman and Bracco said. By having a pre-specified range of expected trading around a price, market participants can easily see "what's clearly erroneous and what's not,'' Bracco said.
The percentage bands would be doubled during the opening and closing periods, the SEC said, and broader price bands would apply to stocks priced below $1.00.
To accommodate more fundamental price moves, there would be a five-minute trading pause – similar to the pause triggered by the current circuit breakers – if trading is unable to occur within the price band for more than 15 seconds.
If approved, all trading centers, including exchanges, alternate trading systems and broker-dealers executing internally, would have to establish policies and procedures reasonably designed to prevent trades from occurring outside the applicable price bands, to honor any trading pause, and to otherwise comply with the procedures set forth in the plan.
The exchanges and FINRA have requested that the SEC approve the plan as a one-year pilot program.
“Upgrading our trading parameters will help our markets retain the confidence of investors and companies,” said SEC Chairman Mary L. Schapiro. “We were focused on improving the structure of our markets before weaknesses were exposed on May 6, and we will continue to be focused on market structure going forward.”
The circuit breaker pilot was initially approved by the SEC on June 16, 2010, and is currently set to expire on Aug. 11, 2011. The circuit breakers apply to securities in the S&P 500 Index and Russell 1000 Index as well as certain exchange-traded funds.
The proposed plan will be posted to the SEC’s website. The commission said it intends to promptly publish the proposed plan in the Federal Register for a 21-day public comment period, and then determine whether to approve it shortly thereafter.