How Risky Are Stock Exchanges?
According to a Bloomberg article , Nasdaq had to unwind a 3 million share error position in Facebook on Friday that resulted in a gain of more than $10 million for Nasdaq.
“Nasdaq wound up selling 3 million shares of Facebook because of its intervention, according to two people familiar with the events. A broker was used to unwind the position that had been placed in the exchange’s so-called error account for $10.7 million, the people said.”
No doubt that this was a unique position for an exchange to find themselves. Most investors still view exchanges as quasi-government utilities and not as capital committing brokers. But is taking a client error really that rare for Nasdaq?
Based on a May 10, 2012 filing with the SEC , errors at Nasdaq may be occurring more frequently that we thought. Nasdaq filed a proposed rule change “to cancel orders when a technical or system issue occurs and to describe the operation of an error account“. Ironically, this filing was made eight days before the Facebook IPO. The filing states:
“Nasdaq or Nasdaq Execution Services may cancel orders as either deems to be necessary to maintain fair and orderly markets if a technical or systems issue occurs at Nasdaq, Nasdaq Execution Services, or a routing destination. Nasdaq or Nasdaq Execution Services shall provide notice of the cancellation to affected members as soon as practicable.”
They have also requested the authority to maintain an error account:
“Nasdaq Execution Services shall maintain an error account for the purpose of addressing positions that result from a technical or systems issue at Nasdaq Execution Services, Nasdaq, a routing destination, or a non-affiliate third-party Routing Broker that affects one or more orders (“error positions).”
What is going on here? Why is Nasdaq requesting this cancellation and error account authority? Is it possible that some of their high volume clients have been getting stuck with some “bad” trades and are demanding that Nasdaq start eating some errors? Are these high volume clients threatening to shift their “liquidity” to another market center if Nasdaq fails to yield to their demands?
Nasdaq has a few examples of possible errors in their SEC filing:
– Error positions may result from routed orders that the Exchange or NES attempts to cancel but that are executed before the routing destination receives the cancellation message or that are executed because the routing destination is unable to process the cancellation message.
– Error positions may result from an order processing issue at a routing destination.
– Error positions may result if NES receives an execution report from a routing destination but does not receive clearing instructions for the execution from the routing destination.
– Error positions may result from a technical or systems issue at the Exchange that does not involve routing of orders through NES. For example, a situation may arise in which a posted quote/order was validly cancelled but the system erroneously matched that quote/order with an order that was seeking to access it.
The potential for errors continues to increase as the message rate and speed of the equity market continues to increase. Should a stock exchange really be in the business of taking error positions? Should a stock exchange be exposed to this kind of risk?