Thu Sep 03 2015
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The NYSE Is Being Attacked… Sort Of

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The New York Stock Exchange is under attack.

One of its biggest rivals, as well as electronic-trading firms that do business on the exchange, is criticizing the way it handled recent swings in the market.

At the heart of the matter is the way the NYSE operates: sticking with human traders at a time when computers have taken over trading, making it faster and more volatile than ever.

The NYSE is a relative throwback in that it still uses human traders, called “designated market makers,” to set the price of shares early on. Other exchanges use computers to do it.

With share prices fluctuating wildly over the past 1o days, the NYSE has invoked a rule — called Rule 48 — that allows the market makers not to announce stock prices at the trading open on four occasions. It did this as recently as Tuesday.

The idea behind the rule is that it should speed up early trading by removing prescribed waiting times, but the invocation of Rule 48 meant numerous stocks went without opening price quotes for several minutes after the open in trading last week. Critics have pounced on the fact that it makes it hard for traders to know what is happening, just when they need that information most urgently.

“For the New York Stock Exchange to publicly defend turning off transparency at the most volatile time for the market is an absurdity,” Chris Concannon, CEO of BATS Global Markets, the second-largest US equity market and a rival to the NYSE, told Business Insider.

Trading in the dark

The NYSE on Tuesday sent out a trader update providing an overview of Rule 48. The note states that while there are no mandatory price indications for stocks that see big moves, there is information on order imbalances.

The update states that the rules are designed “to provide an appropriate level of visibility into the opening price discovery process reducing volatility while also allowing for an efficient market opening during market-wide events.”

Still, the lack of price indications has a significant impact on the market. More than 2,500 NYSE-listed securities had no quotable price at the open at 9:30 a.m. on August 24, according to data from BATS, with more than 800 still not set a price by 9:45 a.m. The lack of prices at the open continued through the rest of the week, with more than 440 stocks not having a quotable price at 9:30 a.m. on August 28.

Craig Viani, vice president of market structure and technology at Greenwich Associates, told Business Insider: “In the case of Rule 48, the concept of reducing transparency at the exact moment it is most needed doesn’t sync with the egalitarian proclamation of modern market structure regulations.”

The staggered opening of the market had broad implications for equity markets in the US.

Numerous indexes, such as the S&P 500, use the opening share price of stocks on their primary exchange to price the overall index, Sayena Mostowfi, principal and head of US equities research at TABB Group, told Business Insider.

“When the stock is not officially open at the primary venue, they use the previous day’s close,” she said. “The index is priced on stale prices.”

ETF chaos

Not having a quotable share price for so many stocks also made it difficult to price and trade shares on exchange-traded funds. That has led to some concerns over the ability to trade ETFs in times of stress.

“It is not helpful to a market maker when we are trying to provide two-sided liquidity on ETFs, and do not have an opening price from the primary venue on a significant portion of the components of the ETF,” Doug Cifu, CEO of the electronic-trading firm Virtu Financial, told Business Insider.

The issues of the past 10 days are likely to put a renewed focus on Rule 48 and whether it is an appropriate way to open the market, given how the equity markets have evolved over the past decade.

Mostowfi at TABB said: “I think at the time when this rule went into effect, it was supposed to reduce instability in the market and also be a speedier way of doing it, but I think that speedier way of doing it is being questioned given the highly automated marketplace we have today.”

There is also likely to be increased attention paid to how various rules and markets interact with one another, such as how indexes are set in times of volatility and how volatility in the share price of a single stock affects exchange-traded funds.

John McCarthy, general counsel at KCG, another securities trader, told Business Insider: “As the markets become increasingly electronified and interlinked, various exchange models need to take into account how their individual market structure affects the market as a whole.”Thomson ReutersTraders on the floor of the NYSE in New York.

Those investigations could have broad implications for the future of the designated-market-maker model at the NYSE and the role humans play in equity trading.

The end of manual trading?

“It is hard to defend manual intervention when it doesn’t add value in this scenario,” Viani of Greenwich Associates said. “Is this the last inhalation before the death rattle of manual trading? I don’t know, but it definitely puts pressure on it.”

Concannon at BATS said he thought the NYSE should adopt an automated method to set prices, to do away with the trading delay at times of stress in the market, the way the vast majority of exchanges do.

“What is necessary is for the NYSE to adopt what all markets around the world have adopted,” he said.

An NYSE spokeswoman defended the designated-market-maker model against the comments from BATS, pointing out that BATS had to cancel its own initial public offering in 2012 after difficulties with its electronic pricing model.

“NYSE has a time-tested model for opening stocks — by contrast, BATS’ proposed all-electronic model is not proven, as evidenced by the manner in which they opened their own stock on its first day of trading,” she said.

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