Standardising The Open In US Markets

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With Richard Vigsnes, Global Head of Equity Trading, Northern Trust
One purpose of the close is to have a benchmark for various instruments and products, and as a result it has generated more scrutiny and is far more structured than the open. Although there are various types of closing mechanisms across the exchange landscape, there is always a primary exchange for an instrument and anyone looking to achieve the benchmark places their orders on the primary exchange and so volume accumulates there. There have been changes and revisions that have occurred as to how volume accumulates and gets represented (timing, offsetting orders, d-quote, etc.) but at least people are aware of these idiosyncrasies and they can be accounted for, so the closing price can be achieved.
On the other side, there is little standardisation of the way the open functions and the events of 24th August brought that very much to the fore. So while there have been individual attempts at standardisation of the opening process, they have been neither coordinated nor well vetted.
A good example of this is NYSE ARCA, where many ETFs are listed. NYSE ARCA has its own opening mechanism with trading bands. In July, those bands were tightened. At that time the VIX was at 15 and the bands were rarely being hit. When the VIX subsequently hit 30, those bands were very much in play and caused a major dislocation that was unexpected. Since then the bands have been wound out past where they sat before they were tightened.
The exchange has thus modified its opening rules three times within a six-month period. Perhaps more thought is required before these changes are made, and some form of standardisation implemented. This is the point where the industry needs to work together to find a solution without having to resort to regulator involvement. The regulators will find it difficult to keep up with and address every market structure issue, so the preference should always be towards the industry working together to agree standards and then to implement them. If the close has more structure around it, it should be possible for the open to have this as well.
When an open and subsequent volatility spike occurs in the manner it did on 24th August, it begs the question as to whether the market is always fair and orderly. In particular, the retail investor may question the market’s ability to treat them fairly. Much of the retail order flow in the US gets sold to market makers and those market makers are then responsible for placing those orders. In a volatility spike, questions inevitably arise as to whether this arrangement disadvantages the retail order flow. There is vigorous debate on both sides, which I’ll set aside for another time. While sidestepping that debate, the interesting thing about the events of 24th August is that no trades were broken and many retail orders were executed against other retail orders, so if you were a retail investor who had buy orders, you most likely got a fantastic price. So, while there was certainly wealth transfer amongst retail investors, as a group they were not singularly disadvantaged.
The US market is one of the deepest and best functioning markets in the world, but there are lessons to be learned from the 24th August dislocation. One is that it would benefit from re-evaluating the rules and structure such that there is transparency and consistency around how instruments open.
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