How NYSE plans to use "flash crash" to reclaim its glory

nyse.gi.top.jpg By Kit R. Roane, contributor


(Fortune) -- Last week's market swoon briefly shaved about $1 trillion dollars off of the value of U.S. equities. But it may have a much more lasting and beneficial effect on the NYSE Euronext -- the exchange world's resident tortoise.

Until last Thursday, the NYSE's gripes about the dangers of market fragmentation and opaqueness seemed like little more than the sour grapes of a former monopoly pining for the old days of fat spreads and easy living. But after a still-inexplicable near 1,000-point drop in the Dow Jones Industrial Average, even U.S. lawmakers are now parroting the Big Board's complaints.

It wasn't long ago that the NYSE itself embraced the electronic exchanges and dark pools it's partially blaming for last week's crash. Although at first it had to be pushed kicking and screaming into the technical nirvana of electronic trading, it snapped up Archipelago Holdings in 2005, then merged with Euronext in 2006; last year it launched its own dark pool in Europe. However, none of that history seems relevant to NYSE executives these days. They prefer to talk up their old-school specialists as a valiant army of Captain Americas who stood firm last Thursday against the recklessness of opaque trading systems and the high-frequency algo-trading horde.

Of course, the NYSE failed to stop the slide, and its curbs -- known as liquidity replenishment points -- may have even exacerbated it. But the NYSE says that's just because its competitors have been allowed to run wild, thanks to unwelcome bits of a 2005 rule called Regulation NMS. The rule was designed to increase competition and provide faster, cheaper ways of making markets.

It's understandable the NYSE is using this moment to shine a light on what differentiates it from its perhaps more hip and nimble competitors, some of which exist in a nebulous regulatory arena where they can skirt many of the rules that harness registered exchanges. The Big Board handles just 23% of NYSE-listed trades today, down from nearly 80% in 2005. Much of that volume now rests with upstarts like BATS Exchange, which began as a storefront alternative trading system in Kansas City in 2006, turned itself into an exchange after capturing a market edge in 2008, and now controls roughly 11% of the daily equity market volume in the United States.

Last Thursday, when the NYSE dusted off its quirky curbs and handed trades over to the humans on the floor, computer-driven trades routed around the NYSE to some of these often less liquid markets. But those who stayed with the slow and steady approach of the NYSE now seem pretty brilliant. In the end, sell orders at the other trading platforms swamped the buys, and a cascade of prices ended with some large-caps briefly trading for pennies a share. Then, in the post-mortem, many of those trades had to be busted, leaving speed-seeking investors licking wounds and holding unwanted stock.

The bugaboo, the NYSE was quick to point out, existed in the regulation that allowed all this unfettered competition in the first place. "Because the New York Stock Exchange had switched to LRPs, and because Regulation NMS allows traders to bypass us, orders were routed to electronic markets that had not mitigated the volatile price declines and which had limited amounts of liquidity on their books," NYSE COO Lawrence Leibowitz told a House Financial Services subcommittee yesterday. "In turn, a spasm of selling spread through the markets with little liquidity, and no opportunity for the markets to pause or human judgment to intervene."

The NYSE does have a point. The sheer number of trading systems being used (more than 40 by the NYSE's count) has added to the complexity of trying to figure out what caused last week's market decline. And the SEC has recently raised its own concerns that market fragmentation -- particularly when stock volume is ending up in shadow systems -- may be increasing market volatility and impairing the ability of investors to get the best execution at the best price. The NYSE estimates that more than 37% of the daily volume in NYSE-listed securities now occurs off exchanges entirely and that 30% of the share volume in all national market system stocks runs through such opaque dark pools.

Although the NYSE is now a hybrid exchange running its own London-based dark pool, that hasn't stopped it from singling out these sources of "undisplayed liquidity" for ire. The exchange recently complained to the SEC that the systems are taking some of the most valuable order flow -- particularly that coming from long-term and institutional investors -- while leaving the dregs (such as the high-frequency traders and other sources of "toxicity") flowing through the exchanges.

Spurred into action by the downdraft, lawmakers and regulators are currently focused on fashioning a system of uniform circuit breakers that would kick in when markets or individual stocks decline more than a certain percent (score one for the NYSE).

But the Big Board has its eye on much broader reform, one that might also benefit its own trading volume even if it doesn't put the NYSE back on the top of the exchange stack. In January, the SEC began seeking comment for a broad review of the effectiveness of regulation in the equity markets. On April 25, the NYSE offered its suggestions, noting the "toxicity" problem and the need to better regulate "off-exchange trading."

Had the NYSE persevered way back when Regulation NMS was first being debated, things might look far different. Back then, the SEC considered making quotes emanating from the NYSE's floor brokers among those covered in its trade-thru rules. This would have effectively slowed down trading last Thursday and universalized the NYSE's curbs, while also helping to protect NYSE old perch as a source of unparalleled volume and liquidity.

Alas, fast markets were seen as fair markets, with the added competition driving down the cost of trading for large and small investors alike. The NYSE had to gobble up electronic exchanges just to compete. While it is too late to turn back the clock, the NYSE can only hope recent market hiccups may make regulators wish for a simpler time when floor brokers held sway and the volume still came easy. To top of page

Frontline troops push for solar energy
The U.S. Marines are testing renewable energy technologies like solar to reduce costs and casualties associated with fossil fuels. Play
25 Best Places to find rich singles
Looking for Mr. or Ms. Moneybags? Hunt down the perfect mate in these wealthy cities, which are brimming with unattached professionals. More
Fun festivals: Twins to mustard to pirates!
You'll see double in Twinsburg, Ohio, and Ketchup lovers should beware in Middleton, WI. Here's some of the best and strangest town festivals. Play
Overnight Avg Rate Latest Change Last Week
30 yr fixed4.41%4.44%
15 yr fixed3.33%3.31%
5/1 ARM3.34%3.55%
30 yr refi4.39%4.41%
15 yr refi3.31%3.30%
Rate data provided
by Bankrate.com
View rates in your area
 
Find personalized rates:
Company Price Change % Change
Comcast Corp 49.17 0.78 1.60%
Applied Materials In... 18.92 0.06 0.32%
Frontier Communicati... 5.86 0.21 3.72%
Oracle Corp 40.13 0.40 1.01%
Twenty-First Century... 32.28 0.63 1.99%
Data as of Apr 16
Index Last Change % Change
Dow 16,409.11 -15.74 -0.10%
Nasdaq 4,087.07 0.84 0.02%
S&P 500 1,862.17 -0.14 -0.01%
Treasuries 2.65 0.01 0.42%
Data as of 9:43am ET

Sections

The company continues to struggle with convincing marketers to pay as much for mobile ads as they do for desktop ads. More

Indian markets are riding high as investors bet that an election and new administration will cure some of the country's economic ills. More

The company continues to struggle with convincing marketers to pay as much for mobile ads as they do for desktop ads. More

Schwinn, Trek and Cannondale are all iconic American bicycle brands. But none of them are made in the United States. More

Pamela Knighton, a 51-year-old social worker from Cuthbert, Ga. who earns less than $25,000 a year, had been really looking forward to her $4,300 tax refund last year. More

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.