Adopting new, U.S. market-wide circuit breakers to halt precipitous drops in individual stocks is "a done deal," a source said on Tuesday, five days after a severe market plunge rattled investors and perplexed regulators.
The circuit breakers would likely trip when individual stocks fell by a set amount in a set time frame. The U.S. Securities and Exchange Commission hosted exchange heads at a meeting Monday, and said afterward the parties agreed to a framework that would strengthen circuit breakers.
The SEC said the six exchanges agreed in principle during a meeting with regulators to a uniform system of "circuit breakers."
Four days after the plunge that sent the Dow Jones industrials down to a loss of nearly 1,000 points in less than 30 minutes, regulators were still saying publicly that they did not know the exact reason for the drop. But there is a growing belief that the varying trading rules on different exchanges contributed to the intensity of the selling and the size of the market's slide.
Senior executives from NYSE Euronext, Nasdaq OMX Group Inc and CME Group Inc will testify to a congressional panel on Tuesday on the sell-off in the stock markets. Slated to testify are NYSE Euronext Chief Operating Officer Lawrence Leibowitz, CME Executive Chairman Terrence Duffy and Nasdaq Transaction Services Executive Vice President Eric Noll, according to the list.
Also appearing will be U.S. Securities and Exchange Commission Chairman Mary Schapiro and U.S. Commodity Futures Trading Commission Chairman Gary Gensler, it said.
People familiar with the situation said regulators believe the disruption was caused by the way different exchanges manage their trades and rapid price swings. A definitive answer could take weeks because regulators are going through information from across the market by hand, said the people, who spoke on condition of anonymity because they were not authorized to discuss the investigation.
The SEC said in a statement that the exchanges, including the New York Stock Exchange and Nasdaq, "agreed on a structural framework, to be refined over the next day" that would more closely align trading rules.
In an effort to calm the market swings Thursday, the NYSE implemented restrictions to slow trading. But many analysts believe the NYSE's action resulted in orders to sell being sent automatically to other electronic exchanges that had no trading restrictions. Selling continued at a furious pace.
The NYSE, Nasdaq and other exchanges already have market-wide circuit breakers. The agreement in principle reached Monday includes three goals to strengthen trading restrictions, said a person familiar with the situation who spoke on condition of anonymity because he was not authorized to discuss the matter.
By Tuesday, the person said, the exchanges will submit a joint proposal to:
- Update existing market-wide circuit-breakers that halt trading if the Dow drops by a certain percentage.
- Create market-wide circuit-breakers for individual stocks. Several big stocks including Procter & Gamble Co. were major contributors to Thursday's plunge. NYSE is currently the only U.S. exchange that has circuit breakers for individual stocks.
- Establish clear rules for which trades should be canceled in cases of extreme volatility. After Thursday's chaos, the exchanges agreed to cancel trades that were called erroneous. Those were trades made during a 20-minute window and whose stock prices had fallen 60 percent or more.
Treasury Secretary Timothy Geithner and other regulators met with the heads of major exchanges Monday. At the meeting Geithner "reinforced the need for a coordinated and timely response to help ensure the proper functioning of our markets," Treasury spokesman Andrew Williams said.
Besides the NYSE and Nasdaq, the exchanges also included BATS Global Markets, DirectEdge, International Securities Exchange and Chicago Board Options Exchange. Officials from CME Group Inc., which operates the nation's biggest commodities markets, and IntercontinentalExchange also met with regulators.
Regulators and exchanges have been examining data from millions of trades trying to determine what caused Thursday's computerized sell-off. The Dow later recovered to close the session down 342 points.
The SEC is leading the investigation with the CFTC. Those agencies are ultimately responsible for overseeing markets, but they rely heavily on exchanges to write and enforce their own rules.
Investors learned from Thursday's plunge that the stock market isn't a monolith. Instead, it is a collection of about 50 competing exchanges and trading networks that work under different rules.
As the decades have gone by, computers programmed to buy or sell stock have taken on a greater share of trading. The NYSE for much of its history relied heavily on specialists, people who brought buyers and sellers together. If no buyers could be found, the specialists bought the stock themselves. This helped investors get the price they wanted, and also helped trading to flow.
With the growth of computers and the high-speed trading they offered, the NYSE has had increasing competition. Nasdaq is the most prominent rival. In recent years, the competition has also come from electronic communications networks, or ECNs, trading networks that automatically match buy and sell orders at specified prices, without an exchange acting as a middleman.
When the NYSE bought its own ECN, Archipelago, in 2006, it began moving away from specialists. The NYSE floor, which had 2,700 to 3,000 people including specialists and traders 10 to 15 years ago, now has 1,500. Therefore there were fewer people to step in and try to stop Thursday's plunge.
Computers using complex mathematical formulas are able to trade millions of shares in milliseconds. That is what happened on Thursday. This kind of trading is known as high-frequency trading, which accounts for two-thirds of all stock trading in the U.S. Proponents say it makes the stock market run more smoothly by efficiently connecting buyers and sellers.
Lawmakers are calling for uniformity among the rules being discussed Monday.
"It appears that our fragmented market structure may very well have contributed to the difficulties we experienced last Thursday," said Sen. Charles Schumer, D-N.Y., a member of the Senate Banking Committee. "Coordination and consistent safeguards between trading venues — and across markets — is essential."
Schumer made his comments in letters to Schapiro, Gensler and the heads of the major stocks and futures exchanges. He also asked the SEC to implement a new centralized market surveillance system to watch for trading problems in all securities markets.