Comment Text:
We respectfully submit this letter in response to the request by the Joint CFTC-SEC Advisory Committee for public comments regarding the Committee’s recommended regulatory responses to the market events of May 6, 2010.
With approximately $6 billion under management, QIM is the largest hedge fund manager in the Southeast and an active computerized trader in the futures markets. It is very important to note that we do not employ HFT techniques. Given that we are a computerized trading firm, but are not high frequency traders, we believe we can offer a unique perspective on the events that led to the May 6, 2010 “flash crash.”
Recently, Commissioner Bart Chilton of the CFTC suggested the need to “expand” and “harmonize” circuit breakers across markets “so we can stop the kind of arbitrage that created a cascading affect across all markets” during the “flash crash” of May 6, 2010.
We greatly appreciate the interest of the CFTC and the Joint Advisory Committee in increasing the quality and fairness of the price discovery process. However, our close examination of the trading history on May 6 reveals that the circuit breakers in place likely only made events worse. In our view, this means that circuit breakers—particularly across international markets—need to be approached with caution and with an eye to workability and unintended consequences.
The Causal Role of the DJ Euro Stoxx 50. The DJ Euro Stoxx 50 (VGM0, June 2010 contract) is based on a pan-European stock index contract, which includes stocks from Portugal, Italy, Ireland, Greece, and Spain. Leading up to May 6, VGM0 was the lead stock index contract reacting to the EU situation and the Greek riots on television. VGM0 is less liquid during the afternoon hours of the U.S. market’s trading session because the underlying cash stock markets in Europe generally close between 11 a.m. and 12 p.m. There are many other sources of liquidity which are highly correlated to VGM0, including stock index futures contracts from a number of European countries, as well as U.S. stock index contracts.
A Circuit Breaker Caused the Volatility. The main reason that the U.S. stock market fell with such incredible speed on May 6 was because of a tripped circuit breaker in Europe on VGMO. VGMO is highly correlated to the S&P 500. On Thursday, May 6th, VGM0 peaked for the day at 06:00ET. It then began leading the way down across the stock and currency sectors. At 14:44:50, VGM0 had dropped 260 points to 2374, and was then shut down and didn’t re-open for 107 seconds. During the time it was closed, the market was in pre-open auction mode. The VGMO reopened down an additional 40 points at 2333, which represented the low of the day for that contract.
Impact on Currency Exchange Rates. EUR/JPY had collapsed prior to the last 60 point collapse on the S&P, and EURCHF was behaving very erratically as well. The rush from the Euro to "safer" currencies such as the Swiss Franc and Japanese Yen was reflected in the huge drops in the Euro-Yen and Euro-Swiss exchange rates. This was indicative of a full-on panic during the European afternoon (morning in the U.S.). EURJPY had previously dropped 2% between 14:00 ET and 14:15 ET. During the fastest move down for ESM0, 14:43 ET and 14:46 ET, EUR/JPY dropped another 2%.
The U.S. Market Follows Europe Down. The S&P 500 contract (ESM0) followed VGM0 down all day long. At 14:44:50, ESMO went down 6.70% to 1086. In the next 43 seconds, while VGMO was turned off, ESMO dropped 30 more points. At its lowest, it was 9.28% down on the day, hitting 1056 at 14:45:33. The very circuit breaker Commissioner Chilton is recommending, which removed the liquidity from the second most liquid futures contract in the world, in fact greatly exacerbated the market decline.
The Difference between Individual Stocks and Indices. We also would like to correct an additional misunderstanding. Commissioner Chilton has stated, "If the Flash Crash had taken place in the morning on May 6th, when EU markets were open, it could have instigated a global economic event." While it is true that the EU markets were closed to European individual stocks at the during the “Flash Crash,” European stock index futures contracts were trading very actively all that day and evening (with the exception of the worst portion of the down-move, as previously detailed).
What This Means for Circuit Breakers. As the above facts show, the final plunge of the U.S. market coincided exactly with the removal of liquidity that occurred when the VGM0 circuit breaker temporarily closed the most liquid futures contract in Europe, which had been leading the U.S. stock market down all day. In other words, this was not a U.S. event; it was European. It became a U.S. event because the global markets are tied together so closely, and the media is so U.S.-centric. Attempting to “harmonize” global circuit breakers (markets which are not perfectly correlated) would generally increase the risk of future flash crashes. Different stocks and other markets would hit the circuit breakers at different times. As each circuit breaker is tripped, more liquidity will dry up, with circuit breaker levels falling like dominoes.
The Joint Committee’s Recommendations. We support the concern of the Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues that present circuit breakers are “unnecessarily lengthy for the present electronic market place, and might, inadvertently, feed the potential market uncertainty.”
Again, we share the enthusiasm of the CFTC and the Joint Commission for strengthening our markets and appreciate your public service. We offer this analysis in a sincere attempt to be helpful. Please let us know if you have any additional questions or if we can assist in any way.
Sincerely,
Jaffray Woodriff
