By Deanna Dobrowsky, Vice President, Market Regulation Policy, IIROC
Canadian regulators, like their counterparts around the globe, have worked to establish a framework to mitigate risk in electronic markets.
We have designed various rules to work as a series of safety nets to protect against events that can lead to unintended outcomes in a high-speed market.
The safety nets are tiered and provide protections, offered by different industry stakeholders, at multiple levels. This layered approach to risk management mitigates risk at different stages in the life cycle of an order, and places the responsibility of protecting the system on various parties.
The four safety nets include:
- At the dealer level, automated controls to prevent the entry of orders that can disrupt a fair and orderly market;
- At the marketplace level, thresholds that prevent orders from executing at unreasonable prices
- Single-stock circuit breakers administered by the Investment Industry Regulatory Organization of Canada that address rapid, significant and unexplained price movement in a particular security; and
- Market-wide circuit breakers which halt trading on all equities marketplaces when there are declines in prices that affect the market generally.
Dealers and Automated Pre-Trade Controls
The first safety net is maintained by participants – dealers that trade directly on marketplaces and may act on behalf of clients. New requirements (the “Electronic Trading Rules” or “ETR”) have expanded on existing rules to specifically require risk management and supervisory controls related to marketplace access and the use of automated order systems. The ETR require participants to use automated controls to prevent the entry of an order that:
- Exceeds pre-determined credit or capital thresholds,
- Exceeds pre-determined value or volume limits, or
- Violates market integrity rules or securities regulation.
In particular, a participant that uses an automated order system must have appropriate procedures to detect, prior to entry, an order that is clearly erroneous or unreasonable and which would interfere with fair and orderly markets. The ETR came into force on March 1, 2013.
The next tier of safety net is at the marketplace level. To date, exchanges and alternative trading systems have not been required to employ volatility controls or trading thresholds. This has resulted in inconsistent, and in some cases non-existent, safeguards on the marketplaces. IIROC has been given the mandate to set marketplace price and volume thresholds, but specific limits have not yet been determined. IIROC has issued a concept paper on this topic and further proposals on marketplace thresholds will be published for comment.
Single-Stock Circuit Breakers
Single-stock circuit breakers, which apply to securities included in the S&P/TSX Composite Index as well as to exchange-traded funds, were put in place in February 2012 to address rapid, significant and unexplained price movements in a particular security. A five-minute halt is triggered across all equities marketplaces if the price of the security swings 10% or more within a five-minute period between 9:50am and 3:30pm. Applying a single-stock circuit breaker to securities in a broad-based index reduces extreme volatility in those securities and, by extension, dampens the volatility of the index.
Market-Wide Circuit Breaker
The fourth and final safety net is the market-wide circuit breaker which halts trading on all equities marketplaces when there are declines in prices that affect the market generally. Market-wide halts of this nature have historically been, and continue to be, tied to the market-wide circuit breaker in the US. Thus trading halts on all Canadian equities marketplaces generally are triggered based on the decline in the S&P 500 Index from its closing value on the previous day.
Underpinning the Safety Nets
As described above, the Canadian safety nets function as part of a multi-tiered system to control short-term, unexplained volatility. Where these measures do not apply or in exceptional circumstances, IIROC will vary or cancel trades that have a negative impact on fair and orderly markets. IIROC’s ability to intervene when required is the final measure strengthening this framework of risk mitigation and management.