Such things would have been unimaginable to the New York City brokers trading securities under the buttonwood tree more than two centuries ago, but over the past couple of years, traders (and investors) have suffered the 2010 flash crash, a glitch that forced the $400m bailout of Knight Capital and software problems that marred Nasdaq’s handling of Facebook’s IPO in May last year. To this litany of market malfunctions must now be added August 22’s three-hour interruption of trading on the Nasdaq because of a connectivity problem.
Stock trading has become ever more dependent on complex, fragmented electronic trading systems. The high-tech trading ecosystem that they constitute, with its algorithm-driven high-frequency trading, is poorly understood. The U.S. Securities and Exchange Commission has been working on rules to make sure that such technological problems, which have bedeviled it, don’t re-occur. Its proposed Regulation Systems Compliance and Integrity — Reg SCI in the argot — is intended, it says, “to replace the current voluntary compliance program with enforceable rules designed to better insulate the markets from vulnerabilities posed by systems technology issues.”
Reg SCI has run into the predictable hostile push-back from market participants on the grounds of the extra costs “the excessive burden of addition regulation” would impose on them. There are three core questions: to whom should it apply, exchanges and trading networks only, or broker-dealers as well; should it apply only to the larger exchanges and trading networks, and if so, what is the trading volume cut-off; and should it be mandatory or voluntary. Each gives scope for interest parties to carve out specific exceptions, as is the tried and trusted practice of Wall Street in drawing the venom from regulatory proposals it does not like.
Competition and innovation in electronic trading systems, as in many areas of human activity, is to be welcomed, but not at the expense of technological stability if its lack puts the system at risk of crashing down. So far, it has only been “glitches,” but they may foretell of something more catastrophic. The U.S. will never be able to claim it has the best financial markets in the world if it doesn’t accept that their technological stability is their bedrock. That is what the SEC has to mandate.