The Securities and Exchange Commission will be scrutinizing its rule book after the bout of volatility triggered a mini flash crash in exchange traded funds during the height of the market selling last Monday.
Diminished transparency at the start of the trading day and a slew of automated trade orders may have contributed to the steep plunge in ETFs last Monday morning before moving back in line once market makers stepped back in. [What Happened with ETFs on Monday’s Mini ‘Flash Crash’]
However, the SEC commissioner Dan Gallagher said the regulatory body will “absolutely” look into ETFs and Rule 48 in response to the irregular blip, reports Michelle Fox for CNBC.
The New York Stock Exchange invoked Rule 48 multiple times to prevent panic trading during market open last week. The relatively new rule allows stocks to open without price quotes ahead of time to allow a more orderly stock market open when there is expected to be large price gaps.
“Rule 48 went into place in 2007 at a time when you were shifting from specialists into electronic trading here on the floor,” Gallagher told CNBC. “It made sense in 2007. Does it still make sense today? We’ll have to look at that.”
However, some traders are now blaming the rule for the 1,278 circuit breakers, or imposed trading halts, that were enacted across major averages last week after shares fell to various levels. With many securities stuck in a holding pattern, the diminished transparency into pricing may have affected market makers’ ability to calculate at what price to step in – market makers help keep ETFs trading near their net asset value, but without the necessary transparency into underlying security prices, the market makers opted to step back and wait for more precise numbers to come in.
Consequently, ETF prices plunged lower as orders failed to get filled, with ordinary investors wondering what was trading and whether they received the correct price on trades, Reuters reports.
“At the open, most markets except for the NYSE opened at 9:30, and if you’re trading an S&P ETF and 50 percent of the S&P is not open, you have some pricing challenges on your hands,” Chris Concannon, head of exchange operator BATS Global Markets, told Reuters.
Now, the SEC will have to analyze the data to try an obviate another similar occurrence during volatile trading. The rules prevented massive canceled trades that followed the flash crash, but the widespread halts may have weighed on a quick market recovery.
“We have a discrete issue in the application of the limit up/limit down circuit breakers to ETFs,” Gallagher added. “Do we need to differentiate ETFs from common stock when we look at circuit breakers? Do they operate so differently that they shouldn’t be just lumped in under the same rule?”
In the meantime, investors should not get sucked into panic selling over extreme short-term volatility. Instead, people should take a more long-term outlook.
“Markets, this is the way they work,” Gallagher said. “They fluctuate. People get scared when they see these fluctuations but this is the greatness of American capital markets.”
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Max Chen contributed to this article.