How Will Exchanges Fare the Next Time Volume Spikes?

Exchanges passed two recent tests of their ability to handle an explosion of trading. They face a third and potentially greater challenge today, when the Federal Reserve decides whether to raise interest rates for the first time in nine years.

On Aug. 24, as anxiety engulfed markets worldwide and prompted one of the worst days for stocks since the aftermath of the 2008 financial crisis, no exchanges reported malfunctions. U.S. stock exchanges weathered a surge in volume to a four-year high of 14.1 billion shares. Last year, a wild session for Treasuries and other assets prompted no obvious malfunctions on Oct. 15, when 11.9 billion U.S. shares traded.

Technical errors at prominent financial markets in recent years have eroded public confidence and prompted regulators to demand they do better. With the Fed's decision likely to unleash another tsunami of volume, exchanges face another big test.

Intercontinental Exchange Inc. (ICE), which runs huge futures markets as well as the New York Stock Exchange, says it is ready.

“Our markets exist to help manage risk and price volatility, and we have in place a robust set of protections to manage through spikes in prices and volumes every day,” Brookly McLaughlin, a spokeswoman for ICE, said in an emailed statement.

One of ICE's biggest competitors, CME Group Inc., said its “systems are designed to manage potential volatility in the markets,” Michael Shore, a CME spokesman, said in an email.

“We are following our normal protocols and procedures,” Joseph Christinat, a Nasdaq Inc. spokesman, said by phone.

In this increasingly automated era of trading, computer breakdowns can halt the world's biggest financial markets, preventing investors from placing trades. Nasdaq's three-hour malfunction in August 2013 froze thousands of stocks, while a CME disruption in August 2014 prevented buying and selling of contracts tied to major stock indexes, Treasuries, oil, and gold. The NYSE's breakdown two months ago was less problematic than it could have been because traders were able to route transactions elsewhere.

Although some of the biggest malfunctions have been in America, exchanges elsewhere have broken down, too. Eurex, one of the world's biggest futures markets, had to delay the start of futures and options trading by more than two hours in July. Russia's primary exchange was down for two hours last week.

Exchanges don't have to break down for there to be a problem. On Aug. 24, even though markets didn't experience malfunctions, some price swings were unusually wide. General Electric Co. and JPMorgan Chase & Co. dropped as much as 21 percent that day, their largest intraday losses since 1987 and 2009, respectively. And some exchange-traded funds also had large, unexplained fluctuations that temporarily untethered them from the prices of their underlying stocks.

Odds that the Fed will boost rates today are 30 percent, according to trading in futures contracts tied to the central bank's key benchmark. The Fed hasn't increased rates since 2006 and has held them near zero since the aftermath of the 2008 global financial crisis.

U.S. exchanges and some of the larger dark pools face a November 3 deadline to comply with rules that require them to plan for technology disruptions that could interrupt trading, clearing and settlement, order routing, and market data. Stress tests will be required to ensure that trading venues can cope with surges in orders or extreme volatility.

Exchanges will have to inform the Securities and Exchange Commission (SEC) of significant breakdowns within 24 hours and issue a written explanation of why the outage happened. The rules shield executives from liability if they can show that they followed their internal policies.

“I don't anticipate seeing any failures or disruptions, but these things happen,” Andy Nybo, a partner at capital markets research and consulting firm Tabb Group LLC, said of the options exchanges that he covers. “They're always ready for a busy day.” With 12 U.S. markets for trading stock options, if there's a problem at one, orders and other activities can be routed to another venue, Nybo said.

–With assistance from Dave Michaels in Washington.

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

Your access to unlimited Treasury & Risk content isn’t changing.
Once you are an ALM digital member, you’ll receive:

Thought leadership on regulatory changes, economic trends, corporate success stories, and tactical solutions for treasurers, CFOs, risk managers, controllers, and other finance professionals
Informative weekly newsletter featuring news, analysis, real-world case studies, and other critical content
Educational webcasts, white papers, and ebooks from industry thought leaders
Critical coverage of the employee benefits and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor