The SEC put circuit breaker rules into effect with Amendment 12 to enact change.
On Nov. 20, 2018, Amendment 12 will go live. Given the relevance of the SEC’s new guidelines, I thought it would be worth revisiting the key provisions of Amendment 12.
The events of Aug. 24, 2015, were a wake-up call for many in the exchange-traded fund (ETF) industry. After a market selloff in Asia spread to North America on that day, a flash crash ensued — creating upheaval in the US equity markets.
In addition to widespread market volatility, ETFs were hurt by diminished liquidity and price dislocation. This was due in part to the breakdown of trading mechanisms that were designed to prevent volatility.
Changes Designed to Stem Market Volatility
Within a year, the Securities and Exchange Commission (SEC) enacted several changes designed to stem market volatility, including abolishing its controversial Rule 48 — a mechanism designed to ensure orderly trading, but one that created its own set of problems.
Left unresolved were harmonization between exchanges and the shortcomings of “limit-up/limit-down” rules. These rules were originally intended to put the brakes on extraordinary market volatility by halting trading in a security. But they occasionally do the reverse by reducing price visibility and preventing a security from recovering after a sharp price drop.
These issues are now being addressed. On Jan. 19, the SEC moved to amend its circuit breaker rules — formally known as The National Market System Plan to Address Extraordinary Market Volatility — by adopting what’s known as Amendment 12.
What is Amendment 12?
Amendment 12 establishes guidelines for reopening trading in securities following a limit-up/limit-down pause.
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Here are the three key provisions:
Following a trading pause, no equity exchange can reopen trading in a security until after the primary listing exchange reopens trading in that security.
This means that liquidity will typically be centralized within the primary market, as opposed to being fragmented across multiple venues for the reopening print. In my view, this attempt at a single point of transparency is essential, particularly during periods of market wide stress.
Trading Pause
It’s important to note that the SEC has set forth an exception to the above rule:
Following a trading pause, the only time trading in a security can resume outside of the primary listing venue is if the primary listing exchange is experiencing problems related to its systems or technology.
This is a precautionary measure that provides redundancy in the event of a technology breakdown. In such cases, trading would resume at the last effective price band.
If a trading pause occurs in the last 10 minutes of a trading day, the primary exchange will, if possible, attempt a closing cross procedure, rather than trying to reopen for continuous trading.
This clarifies how the exchanges would handle a trading pause after 3:50 p.m. ET.
Rather than re-establishing continuous trading for 10 minutes or less, priority is given to an orderly close.
Exchanges may create synthetic price bands when attempting to reopen after a trading pause and there is a reference price available, but no limit-up/limit-down price bands available.
How Will Amendment 12 Influence Trading?
Even a minuscule amount of time between a trading halt and the creation of a new trading range can lead to severe price dislocation for orders in the queue. The dislocation occurs when trading starts before publication of new price bands. The goal of providing synthetic (consistent) price bands across exchanges is to prevent this “leaky band” syndrome.
The changes set forth in Amendment 12 should reduce the number of repeat trading pauses in a single stock or ETF, in my view. I believe they represent progress toward establishing a more standardized process across primary listing exchanges for reopening trading following a trading pause.
This article has been republished with permission from Invesco Powershares.