The extreme volatility in the first few weeks of the coronavirus crash was too much for some trading platforms to handle. But the major U.S. stock exchanges themselves have functioned as normal -- even as they closed their trading floors and began remote operations like most of the financial world. There are some good reasons why.
The Great Recession led to several reforms to help markets operate more efficiently and, in particular, mitigate the incidence of flash crashes. The most notable flash crash occurred on March 6, 2010, when the market lost 9% of its value in a matter of minutes, only to mostly recover within the hour. Flash crashes occur for a variety of reasons and are often exacerbated by high-speed computer trading platforms that rely on algorithms. When there is a glitch in the program or the algorithms recognize certain aberrations, it can lead to an extreme spike in trades.
While stock markets have experienced historic volatility and trading in the past few months -- including historic drops of 12.9% for the Dow Jones Industrial Average and 12% for the S&P 500 on March 16 -- these four mitigation measures established by the Securities and Exchange Commission (SEC) and put in place by the exchanges have been effective.
Regulation SCI and tech upgrades
There have been no outages on the major exchanges during the coronavirus crash and only a few here and there on the various brokerage platforms. Most notably, Robinhood went down for a day on March 2, followed by two shorter blackouts shortly thereafter. The outage was due to "stress" on the infrastructure due to heavy trading volumes, the founders said. These types of outages were far more common on exchanges just a few years ago. Most recently, Nasdaq had a three-hour outage in 2013 and the New York Stock Exchange had a 3.5-hour one in 2015.
A big reason for the system's stability since then is SEC Regulation Systems Compliance and Integrity. Regulation SCI, implemented in 2014, was intended to strengthen the technology infrastructure of the U.S. securities markets and enhance the SEC's oversight. It required exchanges and trading platforms -- those involved in trading, clearance and settlement, order routing, market data, market regulation, and market surveillance -- to not only reduce the occurrence of systems issues, but also improve the resiliency of their systems and have a backup plan.
The exchanges' stability has been tested. The CBOE Volatility Index, or the VIX, broke its all-time high on March 16 when it hit 82.69 (before the crash, it was typically in the mid-teens). And as the country began shutting down physical operations, the exchanges went remote too.
But it appears all the major exchanges, and their customers, have benefited from technology upgrades, per Regulation SCI. For example, the NYSE has been working for the last four years to upgrade its outdated systems. The new Pillar trading platform is designed to speed up trading and enhance the performance, consistency, and resiliency of the exchange. And late last year, Cboe Global Markets finished migrating the last of exchanges to its new Bats technology; Cboe acquired Bats Global Markets in 2017.
In 2013, the SEC implemented a plan to lower the thresholds for marketwide circuit breakers. A circuit breaker causes trading to halt temporarily in extreme circumstances. Previously, the market would halt when it had a single-day decline of 10%, and then again at 20% and 30%. Now it's halted if the S&P 500 falls 7%, 13%, or 20%. At 7% and 13%, the market is halted for 15 minutes to give investors time to consider their next move. At the 20% level, the market shuts down for the reminder of the day.
We saw these halts triggered four times in March -- March 9, 12, 16, and 18. The market hit the 7% threshold on each of those days, but it never hit 13%, coming closest on March 16.
Limit up/limit down
Also in 2013, the SEC instituted a limit up/limit down mechanism to halt extreme price moves by a single stock. If a stock price moves outside a price band, trading is stopped for five minutes. The bands are "set at a percentage level above and below the average reference price of a security over the preceding five-minute period," according to the SEC's rule.
The percentage is based on whether the stock is considered a tier 1 or tier 2 security. Tier 1 includes all securities in the S&P 500, the Russell 1000, and select exchange traded products, while tier 2 is made up of all other National Market System securities, with a few minor exceptions. For tier 1 securities over $3 per share, the price band is 5%. For those between $0.75 and $3, it is 20%, and for those under $0.75, it is the lesser of $0.15 or 75%. For tier 2 securities, the band is 10%.
Stub quote ban
After the 2010 flash crash, the SEC also banned stub quotes, which are offers to trade a stock at a price that's so far off it's not intended to be executed, like an order to buy at a penny or sell at $100,000. Market makers -- intermediaries between buyers and sellers that list buy and sell quotations -- sometimes used stub quotes to meet their obligations. But in the 2010 flash crash, stub quotes made up a sizable number of the trades that were executed at extreme prices. "By prohibiting stub quotes, we are reducing the risk that trades will be executed at irrational prices, and then need to be broken, if the markets become volatile," former SEC chair Mary Schapiro said at the time. Now market makers are required to maintain two-sided quotations within a certain percentage band.
Combined, these measures have provided safeguards and efficiencies to keep the markets functioning during this period of volatility and disruption. Markets are constantly evolving, and so are the issues and challenges they face. As we emerge from this pullback, there will surely be lessons learned for future regulators and participants.