Nine months after lightning-fast computer programs helped produce a terrifying plunge in U.S. stocks, a panel of experts has advised regulators to rein in such trading or face a repeat.
The panel recommended fees for traders who flood markets with thousands of orders a minute only to cancel them and urged regulators to strengthen their supervision of computer-driven trading strategies.
The report, produced after months of study, highlights the difficulties regulators face in a brave new world where trading can take place in a wide variety of different venues, often at breathtaking speed.
Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, likened the situation to the Jeopardy! faceoff earlier this week between an IBM computer called Watson and human contestants.
"The markets have evolved to where we increasingly find more Watsons competing with Ken Jennings and Brad Rutters," he said before the panel presented its recommendations, noting that the computer programs dominating today's markets aren't necessarily as predictable as the one on the game show. "Our regulations have to adapt as the markets increasingly move from man to machine."
The perils of such an environment became clear on May 6, 2010, when major stock indexes plummeted over 5 per cent in a matter of minutes and the shares of some major companies briefly traded hands for pennies before rebounding.
On Friday, an eight-member panel presented 14 recommendations aimed at preventing a repeat of the so-called "flash crash" to Mr. Gensler and Mary Schapiro, chairman of the U.S. Securities and Exchange Commission.
Some of the recommendations build on steps that regulators have already taken. For example, one suggested ways to supplement the trading halts that now occur when stocks or futures exhibit high volatility. Another urged regulators to strengthen a recent move to prevent traders from gaining unfettered access to an exchange's marketplace.
There were also several surprises for market players, including a recommendation to address the "disproportionate" impact that rapid-fire trading has on traffic going into an exchange through some kind of fee regime.
The panel also took aim at the rapidly growing amount of trading that takes place away from exchanges, noting that the firms that provide such services effectively withdrew from the market during the worst volatility on May 6. It suggested that such firms be forced to give investors a better price than public exchanges by a small amount.
That would be a "pretty profound change" which is bound to spur controversy, said Jamie Selway, managing director at Investment Technology Group, Inc. in New York. He added that the panel's recommendations are merely a first step and regulators are still "quite far from a decision."
Indeed, it's unclear how many of the panel's recommendations will be taken up, especially at a time when the demands on regulators are increasing even as their resources appear set to shrink. The SEC and CFTC are also absorbed in the task of writing the myriad rules mandated by the Dodd-Frank Act, the overhaul of the financial sector passed last summer.
Some experts say they're worried that the system remains vulnerable to another flash-crash type event. "Could this happen again in the current state of play? Almost certainly it can, and it could be a lot worse the next time," says Michael Greenberger, a former director at the CFTC and law professor at the University of Maryland.
While regulators are doing their best to tackle the problem, he says, they're also struggling with a shortage of money and resources. "The chances are better than not that we're all going to get hurt if there is not adequate personnel and technology on the regulatory side," Mr. Greenberger said.
Others point out that while the flash crash frightened investors, it didn't do lasting economic damage. They say it showed that today's markets move at extremely high speeds and sometimes in unpredictable ways, highlighting the need for corrective steps such as the ones in Friday's report.
"People drive cars fast, so we have seatbelts and anti-lock brakes," said Ciamac Moallemi, a professor at Columbia Business School in New York. "I would view these measures as positive steps in that direction."