Market Structure Pop Quiz

Pop quiz:  What do you do if you are a stock exchange and on August 24th a good percentage of the Exchange Traded Product (ETP) market flash crashes with trades executed as far as 50% away from the their net asset value?

A)     Invoke the Multi-Stock Event Clearly Erroneous Trade Policy and break all trades that occurred 10% away from the reference price.

B)      Pretend that the trades never happened and propose a new “ETP Aberrant Report Indicator” which would wipe these trades off the tape but not break any of them.

If you guessed “B”, then you are correct and that is exactly what the NYSE is proposing to do.  In a November 12th rule proposal ,  NYSE states:

 “Trades in Exchange Traded Products (“ETP”) occasionally occur at prices that deviate significantly from prevailing market prices and/or an investment fund’s underlying value. These trades may be due to brief price dislocations caused, for example, by unusually large orders, momentary reductions in liquidity, or brief trading or pricing errors by individual market participants. The resulting trades may occasionally establish a high, a low or last sale price for a security that does not reflect price discovery in the fund holdings in a manner that is representative of ongoing trading in an ETP tracking the real-time value of the fund’s underlying securities, and could impact statistics for the investment fund as computed by third parties in a way that is inappropriately reflective of very short-term market impact rather than ongoing fund performance, leading to investor confusion.”

NYSE wants trades that “do not accurately reflect the prevailing market for an ETP” to receive an aberrant report indicator which would essentially wipe the trade off the tape (NYSE proposes this indicator for trades that occur “at the greater of a minimum of 50 cents or 50 basis points away from a previous trade or reference price”).  Remember, the trades still occurred but with the wave of a magic wand, NYSE will make them disappear from the trade records as if they never happened. 

We understand why NYSE is proposing this and it probably has something to do with their large ETP issuers not being very happy about the events of August 24th.  But we would have hoped that rather than sweeping the problems of August 24th under the rug, NYSE might have proposed some more legitimate market structure reforms such as reviewing market maker obligations. 

 NYSE later goes on to say in their filing:

The Exchange believes its proposal to append an Aberrant Report Indicator to certain trades is a reasonable means to alert investors and other market participants that the Exchange believes that the trade price of an ETP executed on its market does not accurately reflect the prevailing market for the ETP.”

So much for the efficient market hypothesis.  “Alerting investors” doesn’t help them with their losses that they sustained on August 24th which JP Morgan estimated at $250 million.  We’re saddened to see that rather than address the real causes of August 24th, NYSE is proposing just another band aid to cover up yet another market structure wound.