Despite criticism, the New York Stock Exchange has vowed to continue its program for trading pauses.
At the urging of the Securities and Exchange Commission, exchanges started to implement a marketwide, single-stock circuit breaker to cover names in the S&P 500 index on June 11. But the NYSE said it would continue to employ its own trading-pause program, called Liquidity Replenishment Points, in addition to the SEC-mandated circuit breaker.
LRP critics argue that the NYSE program intensifies, rather than moderates, volatility. They also say that LRPs contributed to the sudden disappearance of liquidity during the May 6 "flash crash."
The NYSE argues that LRPs are a beneficial component of the market structure. "We believe they add value, and that they’re complementary to the new volatility trading pauses," said NYSE spokesman Ray Pellecchia.
Trading halts have become popular conversation across the industry thanks to the events of May 6, when the markets gyrated dramatically over a 20-minute span. As trading exploded that afternoon, the NYSE’s LRPs were triggered many thousands of times.
But they were triggered to ill effect, according to Jose Marques, global head of electronic equity trading at Deutsche Bank.
The LRPs definitely contributed to the lack of liquidity on May 6, he said, because the NYSE took itself offline at a time when the market was under stress. Other venues were able to route around the NYSE when it switched to a manual mode and was no longer able to participate, he said.
"Having the NYSE with a separate, additional [circuit breaker] … is really not helpful," Marques said.
Others agree. One competitor of the NYSE who did not want to give his name said he understood why exchanges would want to have their own trading-halt mechanisms to limit volatility in the stocks they list. But he said there can be trouble whenever a halt is issued on one exchange and other markets continue trading. And furthermore, he added, with a marketwide circuit breaker in place, individual trading pause mechanisms aren’t necessary. "I think it’s difficult to pause one market and not all markets," he said.
Nomura Research Institute, an affiliate of giant Japanese bank Nomura Securities International, took a look at the repercussions of triggered LRPs on May 6 in its study of the flash crash. It concluded that the triggering of the LRPs coincided with the disappearance of high-frequency traders’ buy orders.
"NYSE LRPs are suspected of not only failing to fulfill their intended purpose of stabilizing the market," the NRI wrote, "but having the opposite effect by causing mass rerouting of sell orders to nearly bidless non-NYSE trading venues as high-frequency traders vanished from the market."
The SEC has said it wants to determine whether LRPs played a role on that day in the net loss of liquidity that produced the extreme volatility in prices. In its joint report with the Commodity Futures Trading Commission on the preliminary findings of May 6, it said that it would closely examine LRPs and other procedures exchanges use for handling or executing orders to establish whether they slow liquidity down unnecessarily.
If LRPs were responsible for ultimately exacerbating price volatility, the SEC and CFTC wrote, "it potentially could have caused some NYSE securities to decline further than the broad market decline."
But the report also noted how it’s possible that the LRPs actually reduced volatility on May 6 by assembling liquidity that absorbed some of the excess selling interest. Either way, the NYSE would not comment on the SEC’s intentions for LRPs.
Joseph Cangemi would. The head of equity sales and trading at ConvergEx’s global electronic trading unit likes LRPs. Cangemi traded for many years on the NYSE floor and is also the current vice chairman of the Security Traders Association. "The NYSE’s LRPs serve a good purpose," he said.
An LRP pauses automated trading on the Big Board when the price of an NYSE-listed stock rises or falls by roughly 2 to 4 percent, Pellecchia said. When an LRP is triggered, trading on the NYSE will halt for a time to allow additional liquidity to enter the market. Then, trading in the name on the NYSE reverts to manual auction-style, permitting new bids and offers. A market maker then tries to amass a large, price-discovering trade in an attempt to attract liquidity on the other side of the buy-sell equation, Pellecchia added.
The average LRP process takes a few seconds. Typically, LRPs are triggered a couple hundred times a day, Pellecchia said. On May 6, that number was in the tens of thousands of times.
In NYSE-listed names, LRPs would be triggered prior to the new, industrywide circuit breaker. That circuit breaker would pause trading in S&P 500 stocks if the price moved 10 percent or more, up or down, in a five-minute period.
