Themis Trading On The SEC's Flash Crash (Non) Report
From Sal Arnuk of Themis Trading
CFTC – SEC Joint Commission Report Part Deux
Summary of the Joint CFTC/ SEC Recommendations Regarding Regulatory, Response to the Market Events of May 6th, 2010
The report is out. Click here to read the 14 page report.
The Joint CFTC/SEC committee makes 14 recommendations which they intend
to focus on to ensure the integrity of our connected market place. We
would like to highlight the 3 recommendations that we think are “news”
today, and that we have particularly expressed concern about over recent
years: Recommendations 10, 11, and 12, which deal with order
cancellation fees, internalization, and trade-at rules.
Missing in the report, however, is any discussion of proprietary
exchange data feeds, the proliferation of exchanges, or minimum order
life. Also, this report is a stark contrast to the September 30th
report, which focused more extensively on an algorithm trading eMini
futures from a large money manager. The HFT community, at that time,
focused on that aspect of the report extensively. This report is an
improvement, as it does begin to examine structural inefficiencies and
risks in our current market structure.
10. The Committee recommends that the SEC and CFTC explore ways to
fairly allocate the costs imposed by high levels of order cancellations,
including perhaps requiring a uniform fee across all Exchange markets
that is assessed based on the average of order cancellations to actual
transactions effected by a market participant.
This is a win that they are recommending ANY type of cancellation
fee. However we note that when you read the wording carefully, it will
not be a recommendation for a fee on all cancellations; rather it will
be a recommendation for a fee on cancellations that exceed a firms
“normal pattern”. Lots of wiggle room here folks.
11. The Committee recommends that the SEC conduct further analysis
regarding the impact of a broker-dealer maintaining privileged execution
access as a result of internalizing its customer’s orders or through
preferencing arrangements. The SEC’s review should, at a minimum,
consider whether to (i) adopt its rule proposal requiring that
internalized or preferenced orders only be executed at a price
materially superior (e.g., 50 mils for most securities) to the
quoted best bid or offer, and/or (ii) require firms internalizing
customer order flow or executing preferenced order flow to be subject to
market maker obligations that requires them to execute some material
portion of their order flow during volatile market periods.
A related concern has to do with the effects.
WOW. Look into obligations for internalizers too? While we don’t
hold particularly valuable any of these affirmative obligation rules, it
is nice to see that they are acknowledging how damaging the
internalizer model has been.
They also feel at a minimum that internalizers should price improve
by 50 mils. This is an accommodation for crossing pools that tend to
trade larger blocks, and when they trade sub-penny, they trade in the
middle of the spreads (half a penny). THIS IS HUGE.
12. The Committee recommends that the SEC study the costs and
benefits of alternative routing requirements. In particular, we
recommend that the SEC consider adopting a “trade at” routing regime.
The Committee further recommends analysis of the current “top of book”
protection protocol and the costs and benefits of its replacement with
greater protection to limit orders placed off the current quote or
increased disclosure of relative liquidity in each book.
They want to look into protecting Depth Of Book! This is big also.
Their other points, which were widely expected, follow:
1. The Committee concurs with the steps the SEC (working with the Exchanges and FINRA) has taken to
a. Create single stock pauses/circuit breakers for the Russell 1000 stocks and actively traded ETFs1
b. Enact rules that provide greater certainty as to which trades will
be broken when there are multi stock aberrant price movements, and
c. Implement minimum quoting requirements by primary and supplemental
market makers that effectively eliminate the ability of market makers
to employ “stub quotes”
2. The Committee recommends that the Commissions require that the
pause rules of the Exchanges and FINRA be expanded to cover all but the
most inactively traded listed equity securities, ETFs, and options and
single stock futures on those securities.
3. The Committee recommends that the SEC work with the Exchanges and
FINRA to implement a “limit up/limit down” process to supplement the
existing Pause rules and that the Commissions clarify whether securities
options exchanges and single stock futures exchanges should continue to
trade during any equity limit up/down periods.
4. The Committee recommends that the CFTC and the relevant derivative
exchanges evaluate whether a second tier of pre-trade risk safeguards
with longer timeframes should be instituted when the “five second limit”
does not attract contra-side liquidity.
5. The Committee recommends that The Commissions evaluate the present system-wide circuit breakers and consider:
i. reducing, at least, the initial trading halt to a period of time as short as ten minutes
ii. allowing the halt to be triggered as late as 3:30 pm and
iii. using the S&P 500 Index as the triggering mechanism.
This makes immense sense. IT is not a Dow world, after all, and more
importantly it is easier to coordinate the many S&P 500 related
6. The Committee supports the SEC’s “naked access” rulemaking and
urges the SEC to work closely with FINRA and other Exchanges with
examination responsibilities to develop effective testing of sponsoring
broker-dealer risk management controls and supervisory procedures.
7. The Committee recommends that the CFTC use its rulemaking
authority to impose strict supervisory requirements on DCMs or FCMs that
employ or sponsor firms implementing algorithmic order routing
strategies and that the CFTC and the SEC carefully review the benefits
and costs of directly restricting “disruptive trading activities “with
respect to extremely large orders or strategies.
Algo providers may have an obligation to develop procedures, and have
responsibility for, the actions of their clients, and how those clients
interact with the algo technology.
8. The Committee recommends that the SEC evaluate the potential
benefits which might be gained by changes in maker/taker pricing
practices, including building in incentives for the Exchanges to provide
for “peak load” pricing models.
Extra Rebates! Extra Fees! They will explore “what if” rebates were
greater during times of stress, and “what if” it were more expensive to
9. The Committee recommends that the SEC evaluate whether incentives
or regulations can be developed to encourage persons who engage in
market making strategies to regularly provide buy and sell quotations
that are “reasonably related to the market.”
Will any mandated obligation outweight potential huge losses?
Reasonably related to the market? How do they deal with a quote that can
be cancelled before you hit it? Will firms like Getco have a huge
advantage since their technology is the fastest (and their colo the
13. The Committee recommends that the Commissions consider reporting
requirements for measures of liquidity and market imbalance for large
14. The Committee recommends that the SEC proceed with a sense of
urgency, and a focus on meaningful cost/benefit analysis, to implement a
consolidated audit trail for the US equity markets and that the CFTC
similarly enhance its existing data collection regarding orders and
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