Wendy Rudd of the Investment Industry Regulatory Organization of Canada (IIROC) describes the Canadian approach to circuit breakers, minimum size and increment requirements and the role of dark liquidity.
What is currently driving the regulatory policy agenda with regard to circuit breakers? Globally, and Canada is no exception, we have seen the introduction of new rules in several areas related to the mitigation of volatility. Circuit breakers are just one of those areas. While some reforms may have been in the works already, the Flash Crash of May 2010 certainly served as a catalyst for a broader debate about market structure, trading activity and the reliability and stability of our equity trading venues.
Volatility is inevitable, so when does it become a regulatory concern? From our perspective – and we regulate all trading activity on Canada’s three equity exchanges and eight alternative trading systems – we see it as a priority to mitigate the kind of shortterm volatility that interrupts a fair and orderly market. We do not expect to handle this role alone; it is a shared responsibility that includes appropriate order handling by industry participants and consistent volatility controls at the exchange/ATS level.
What are the benefits of harmonizing circuit breaker rules with US markets? One main advantage to a shared or complementary approach is that it limits the potential for certain kinds of regulatory arbitrage in markets that operate in the same time zone. Many Canadian-listed stocks also trade in the US, and roughly half of the dollar value traded in those shares takes place on US markets each day.
Which approaches are you considering taking for market-wide circuit breakers? We are monitoring developments in the US, where regulators have proposed changes which include lower trigger thresholds calculated daily, using the S&P 500 (instead of the Dow Jones Industrial Average) and shorter pauses when those thresholds are triggered. We are currently exploring options for marketwide circuit breakers which include continuing our existing policy of harmonizing with the US, pursuing a ‘made-in-Canada’ alternative or identifying a hybrid approach that does a little bit of both. At this stage, we are soliciting industry feedback on the merits of these three approaches. With the help of that feedback, we expect to be able to choose the appropriate path soon. It is important to note that these kinds of circuit breakers are an important control but have traditionally acted more as insurance – they have only been tripped once in the US and Canada since being introduced in 1988.
How similar is IIROC’s new Single-Stock Circuit Breaker (SSCB) rule to the US rules? Single-stock circuit breakers are relatively new for both jurisdictions. The US and Canada have implemented SSCBs which are similar in that a five-minute halt is triggered when a stock swings 10% within a five-minute period. Otherwise, the Canadian approach differs in several ways. For example, our SSCB does not trigger on a large swing in price if a stock were trading on widely disseminated news after a formal regulatory halt.
Do you believe circuit breakers, market-wide or single-stock, have a deterrent effect on momentum trading? We did not set out with a prescriptive approach to influence or change trading behaviour or strategy. IIROC’s circuit breaker policies were developed to provide added insurance against extraordinary short-term volatility. We intend to study the impact of any changes and we may be able to learn more about the impact of policy changes on trading behaviour.
Richard Nelson, Head of EMEA Trading for AllianceBernstein, shares his perspectives on navigating volatility, prospects for developing exchanges, new regulation and the balance between transparency and best execution.
FIXGlobal: How much does volatility affect the way that you trade and what are you using to measure volatility on the desk?
Richard Nelson, AllianceBernstein: We use an implementation shortfall benchmark, so the longer we take to execute an order, the wider the range of possible execution outcomes. Volatility, in particular intraday volatility, increases that potential range, so you could see very good or very poor execution outcomes as a result. In reaction to that, we take a more conservative execution strategy or stretch the order out over a longer time period. And, for instance, if we get a hit on a block crossing network, we will not go in with as large a quantity as we would in a less volatile market. In that way we try to dampen down the potential effects that volatility might have on the execution outcome.
FG: How is AllianceBernstein using technology to improve performance and cut costs on the trading desk?
RN: It plays quite an important part and has done so for quite a while. We are pretty lucky in that we have a team of quant trading analysts. Most of them are in New York, but we have one here on the desk in London, and they help us to analyze the changing market environment and recommend the best ways we can adapt to it. Our usage of electronic trading has increased in the last year, we benefit from the quant trading analysts looking at the results we are achieving with our customized algorithms. We are more confident about getting good consistent execution outcomes because they are monitoring the process and making the necessary changes to ensure the results are what we are expecting. This, in turn, increases the productivity of the traders I have on the desk. They can place their suitable orders into these algorithms and let them run which allows us to focus on trying to get better outcomes on our larger, more liquidity-demanding orders.
On top of that, as market liquidity has dropped significantly, we are trying to make sure we reach as much potential liquidity as possible, and ideally we want to do that under our own name rather than go to a broker who then goes to another venue. We believe that going directly into a pool of liquidity is better done under your own name rather than via a broker because we can then access the ‘meaty’ bits of the pool rather than the ‘froth’. We are looking into ways of doing that but one of the problems is that, potentially, you get a lot of executions from a number of different venues, which results in multiple tickets for settlement. Our goal is to access all these potential liquidity pools, yet also control our ticketing costs, which are a drag on performance for clients.
FG: Was it an intentional change to increase electronic trading or was it a byproduct?
RN: It was a little of both. Our quant trader has been with us for two years and when he first arrived he had to sort out the data issues that exist in Europe and to clean things up. Once the data integrity was sorted out, we looked at different ways of employing quantitative analyses. Having somebody here who is constantly monitoring the execution outcomes means we can proceed down this path with real confidence. As a London firm, we were a little behind in our adoption of electronic trading, but now we are in the middle of the pack in terms of usage. It makes sense from a business and productivity perspective that there are many orders that do not need human oversight, which are best done in algorithms.