The U.S. Securities and Exchange Commission is probing how the splintering of the U.S. stock exchange business into dozens of markets may have contributed to Thursday's dizzying plunge in shares, a review that will have major implications for Canada's changing trading landscape.
The U.S. has as many as 50 separate venues for trading, and many analysts say that the way orders bounce back and forth between different markets with different rules may have exacerbated the selling. For example, the New York Stock Exchange briefly suspended trading in some stocks, while they continued to trade on other markets.
"We are scrutinizing the extent to which disparate trading conventions and rules across various markets may have contributed to the spike in volatility," the SEC said, adding that the volatility "is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed."
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What the SEC finds will be closely watched in Canada, which is steadily moving toward a U.S.-style trading environment with multiple markets.
For all intents and purposes, the U.S. stock market ceased to function properly for about 10 minutes in the late afternoon Thursday, as buyers vanished for reasons that aren't yet clear. Some giant companies' stock prices fell to almost nothing, forcing Nasdaq and the New York Stock Exchange to cancel thousands of trades in hundreds of stocks because markets were so out of whack.
Friday, U.S. regulators and exchanges were still searching for the trigger. Experts said the picture should become clearer soon, given the mounting political pressure for answers. U.S. policy makers announced that they would hold a congressional hearing on Tuesday to probe what went wrong.
Regulators need to take a close look at the splintering of the securities industry and how exactly orders are diverted from one market to another, said Michael Gorham, former director of market oversight at the U.S. Commodity Futures Trading Commission.
"You should not have the case where Accenture falls to a penny and then jumps back to $40 again," he said.
In both Canada and the U.S., the shift to multiple markets is happening with the blessing of regulators, who want competition and innovation.
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Canada's system remains much more centralized than in the U.S., where the New York Stock Exchange now hosts trading for only about a fifth of the total volume in the stocks it lists. The TSX and its Venture exchange, by contrast, still have a combined market share of about 75 per cent, and there are only a handful of competitors.
"There is a lesson there [in Thursday's events]that fragmented markets present new kinds of challenges," said Kevan Cowan, president of the TSX Markets division of TMX Group Inc.
Perhaps because trading is still more centralized, Canada's markets performed better Thursday, with few trades taking place at prices that regulators deemed unfair. The Canadian market's main regulator said it cancelled a grand total of 12 trades, and re-priced another 218, across only four stocks.
Another factor is that the electronic traders who dominate the U.S. market, and who are being fingered as one of the possible causes of Thursday's wild plunge, are not nearly as big a part of the Canadian stock market.
Estimates are that busy electronic traders such as Tradebot Systems Inc. are on at least one side of 70 per cent of all U.S. stock transactions on many days as they quickly trade in and out of stocks to pick up a penny here and a penny there.
When some electronic companies saw markets start to look strange on Thursday, some, including Tradebot, shut down. That pulled thousands of buy orders out of the market, causing many stocks to drop as if the floor fell out from under them. Other computer trading programs at so-called quantitative firms may then have kicked in and started to sell.
In the U.S., "the quant element is a big element, and some of the machines, they went rip roaring away when things moved," said Nick Thadaney, head of brokerage ITG Canada, a mainstay of large institutional investors that do big trades.
In Canada the effect was much more muted, probably because electronic trading is a factor in only about 25 per cent of all trades in Canadian markets.
Michael Greenberger, a professor of law at University of Maryland and a former director at the CFTC, said that there will be "very strong controls" imposed on high-speed trading.
"High-speed trading has many, many problems, including giving those who can afford to do it an unfair advantage," he said. "Now we see it can destabilize the market and aggravate volatility in a rather dramatic way."