Saturday, October 2, 2010

CME Questions SEC-CFTC Flash Crash Conclusions: Calls For End To Stub Quotes

The CME Group, consisting of the CME, CBOT and NYMEX derivative markets, issued a response to the SEC-CFTC May 6 flash crash report. The CME Group disagrees with the SEC-CFTC report's conclusions that the E-mini S&P500 futures contract was the cause of the market events of May 6.

The CME response states in part:
The [Joint SEC-CFTC] report references a series of bona fide hedging transactions, totaling 75,000 contracts, entered into by an institutional asset manager to hedge a portion of the risk in its $75 billion investment portfolio in response to global economic events and the fundamentally deteriorating market conditions that day. The 75,000 contracts represented 1.3% of the total E-Mini volume of 5.7 million contracts on May 6 and less than 9% of the volume during the time period in which the orders were executed. The prevailing market sentiment was evident well before these orders were placed, and the orders, as well as the manner in which they were entered, were both legitimate and consistent with market practices. These hedging orders were entered in relatively small quantities and in a manner designed to dynamically adapt to market liquidity by participating in a target percentage of 9% of the volume executed in the market. As a result of the significant volumes traded in the market, the hedge was completed in approximately twenty minutes, with more than half of the participant's volume executed as the market rallied – not as the market declined. Additionally, the aggregate size of this participant's orders was not known to other market participants.

Additionally, the most precipitous period of market decline in the E-Mini S&P 500 futures on May 6 occurred during the 3½ minute period immediately preceding the market bottom that was established at 13:45:28. During that period, the participant hedging its portfolio represented less than 5% of the total volume of sales in the market.

Academic and empirical evidence has firmly established that stock index futures markets are significantly more liquid than alternatives, including broad-based index ETF markets. As a result, stock index futures markets typically function as the leading price indicator and fundamental broad-based equity market movements are generally first evidenced in CME's E-mini S&P 500 futures markets. The report also recognizes the inter-relationship of the E-mini S&P 500 stock index futures market and the highly correlated SPDR ETF markets.
The CME Group made the following recommendations:
  1. Require uniform price limit policies across all equity and equity derivative markets.
  2. Require the adoption of stop logic functionality or similar protocols to mitigate the impact of transitory liquidity gaps by briefly pausing the market. As described in the Report, on May 6th, CME's Globex stop logic functionality was triggered and trading of E-Mini S&P 500 futures contracts was paused for five seconds. This pause permitted market participants to provide much needed liquidity by entering, modifying or canceling orders, ultimately leading to the market rally that restored equilibrium in the equity markets that day.
  3. Eliminate stub quoting procedures in cash equities markets whereby orders to purchase or sell valuable securities can be executed at a penny or a mere fraction of their true value.
  4. Establish uniform and pre-established standards for busting or price adjusting clearly erroneous transactions.
Read the entire CME Group statement about the SEC-CFTC May 6 flash crash report here.

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