Yabba-Dabba-Doooo! Let’s Talk About Closing Time
At the Slate Rock and Gravel Company, the dodo bird – sundial watch system is what closed the plant each day. Fred Flintstone lived for the smooth and successful operation of that process. In all the episodes we at Themis have watched, there has not been a failure of that system. That’s not to say that it never did fail, or never would, mind you… Actually, we do wonder if Mr. Slate had a backup system.
Let’s talk about the close in our markets in the United States. The “official close” on the two major primary listing stock exchanges is fairly important. It’s important because all types of investors price their holdings each night using those prices. It’s important because (increasingly lots of volume trades on these closing prints; the prices of these closing prints are, for lack of a better word, more “legitimate” than the millions of other prices taking place throughout the trading day. It’s also important because a whole slew of institutional algorithms make assumptions about volumes at the close, and trade at other times of the day accordingly; a botched close throws off all those algorithms, and a botched close insures they won’t do what they are designed to do.
Once upon a time, the closing auction clearing prices were fairly simple; investors entered market on close orders (MOC), or limit on close orders (LOC), demand was matched with supply and a clearing price was arrived at. Of course the processes have become more complicated. Imbalances get broadcasted often enough to help aid computer prop traders. There are these things called d-quotes on the NYSE, which while originally intended to help floor brokers transact institutional investor orders, now are mostly used by high frequency traders playing The Price Is Right with the close.
Regardless, the close is what it is today – imperfect, and increasingly a greater percentage of the day’s volumes in stocks are transacting at that time. This is why when NYSE had its Glitch a few weeks back, the street – investors, high-speed traders, and brokers – were concerned whether or not NYSE would be able to hold their closing auction. There was even speculation that ITG wanted to step in and be a backup for the NYSE closing process.
Today we want to alert you to a story in the Wall Street Journal, where NYSE and NASDAQ are filing to step in and be backups for each other, should one of the two markets be unable to hold their auction.
NYSE’s Tom Farley:
“The role the closing auction plays in establishing reliable closing prices and facilitating liquidity is recognized by market participants and regulators alike.We look forward to working with the industry and the SEC to implement this resiliency plan for the public markets on behalf of investors.”
NASDAQ’s Tom Whitman:
“We devote significant resources to ensure redundancy, and this is a way to further enhance that.”
It’s quite nice, and likely a great idea that the two fierce stock exchange rivals cooperate to back each other up for such an important part of the US stock Market’s trading process.
However, the details can be hairy to sort out between them. As noted in our 2010 communication to you, NASDAQ and NYSE run the auctions quite differently. The cutoff times are a source of difference, as are the use of d-quotes, DMMs, what imbalance information is broadcast, how often that information is broadcast, as well as order types. Would the backing-up exchange step in and use its own rules and processes for the close? Would it program and maintain a system to step in and use the source exchange’s procedures?
We look forward to reading NYSE’s and NASDAQ’s SEC rule filings when they are submitted. Indeed it would be remarkable cooperation, and technological integration success, if NYSE and NASDAQ can work out those issues. It would likely be good for the markets as well. We all know that there is no way any of us (or any regulator) will be able to prevent “glitches” and technological failures from happening in the future.
But perhaps it is a pretty good idea to have a back-up system.