Securities Industry Moves To Scrutinize Market Glitches

Challenge: A series of technical glitches that have disrupted U.S. stock trading has prompted regulators to insist that exchanges take steps to boost resiliency in the underlying market infrastructure.

Why It's Important: Investors have gone through a series of market-wide failures, starting with CBOE's delayed opening of its main options market in April 2012, followed by the Facebook IPO fiasco in May 2012; Knight Capital's system-failure-induced trading loss this past August; Nasdaq OMX's Aug. 22 outage of the consolidated market data feed -- known as the securities information processor, or SIP -- that shut down trading on 2,700 stocks for three hours; and Goldman Sachs' routing of erroneous stock options orders, also in August. "It was highly disruptive," says Sudhanshu Arya, managing director and head of technology for electronic brokerage at ITG, referring to the Nasdaq SIP failure. Some industry leaders worry that the continuation of these technological outages is eroding the confidence of retail investors and preventing companies from doing IPOs on exchanges.

If you ask the exchanges, the technology they're running is old. This stuff is ancient and has a lot of issues." -- Emmanuel Doe, Interactive Data Corp.

Where The Industry Is Now: On Sept. 12, SEC Chairman Mary Jo White met with exchange heads in Washington to discuss the spate of outages and insisted that exchange rivals work collaboratively to strengthen critical infrastructure and resiliency. As homework, White gave the high-profile CEOs 60 days to come up with a comprehensive action plan to address standards for highly resilient and robust systems. Various measures are being considered, including better systems for testing and requiring exchanges to have "kill switches" in place to stop trading in the event of a technological breakdown.

Right now everything is in a conversation stage, says Emmanuel Doe, president of Interactive Data's trading solutions businesses. "There are all these proposals out there [for] how to regulate these technical glitches. The exchanges need to re-evaluate their infrastructure to handle current volumes," says Doe. On March 7 the SEC also proposed Regulation Systems Compliance and Integrity to bolster systems strength among operators of automated trading systems. Regulation SCI would require market participants to implement policies and procedures concerning the technology systems' capacity, integrity, resiliency, availability and security. SCI would apply to 44 entities, including self-regulatory organizations, ATSes, plan processors (SIPs) and one clearing agency (DTCC). However, Regulation SCI would not cover large broker-dealers that could still cause an outage without being an ATS operator, Arya says.

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Focus In 2014: The industry will continue to debate the best course of action for strengthening the market infrastructure, while the SEC will continue to work on Regulation SCI. But some industry participants contend they are more qualified to monitor systems on their own.

"Firms [must] continue to invest in market stabilizing technology," says ITG's Arya. "We maintain that people and technology that are closest to a given product in the firm are most qualified to identify what the caveats are. Equally important, a firm understands those holes and is prepared to deal with external outages." While there is a role for the SEC to play in terms of demanding service levels and monitoring outages, Arya doesn't think regulators should come in and tell brokers how to test and what development environments should look like.

Industry Leaders: Regulators, broker-dealers, ATS operators, clearing agencies and exchanges. "Institutions play a big role in this as they are the end consumers," notes Arya.

Technology: Exchanges are considering the development of a "central testing facility" for new trading software, according to The Wall Street Journal. In a speech delivered to an industry conference, Nasdaq OMX CEO Bob Greifeld said exchanges and brokers needed a testing facility to catch potential software bugs as way to avoid market technology failures.

Price Tag: Regulation SCI would cost the industry $66 million to implement, according to SEC estimates. ITG says the cost will be three to four times that amount. Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio