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October 26, 2001
SPEECH OF ROBERT K. WILMOUTH
REMARKS GIVEN TO STANDING COMMITTEE 2
On behalf of the IOSCO Consultative Committee, I want to thank you for the opportunity to offer this presentation on the topic of trading halts. I also want to thank Mr. Salini specifically for his invitation to allow me to discuss the concerns for the Consultative Committee in the matter of trading halts. Your project to study trading halts in markets for securities and securities derivatives is an excellent example of the type of project where the Consultative Committee can be of great assistance. The issues surrounding trading halts are directly relevant to the Consultative Committee's 50 plus members, most of whom are on the "front lines" in dealing with trading halt issues as operators of organized markets for securities, derivatives or both. We hope our involvement in this project will lead to further cooperation and interaction between the Consultative Committee and the Technical Committee. (May refer to other topic on consultation.)
To prepare this presentation, we solicited the views of the Consultative Committee members through a survey questionnaire. We decided to conduct a survey to ensure that our comments reflect the Consultative Committee's diverse membership. We also designed our survey to focus on the opinions and first hand experiences of our member markets, to complement the survey that you circulated to government regulators to obtain information on the current legal authority, practices and procedures for implementing trading halts within the countries represented by your members.
We have prepared a written summary of the responses to our opinion survey. We are also preparing a compilation of the responses into a single report, which we are happy to share with you. A number of the respondents provided detailed, thoughtful responses that you may find of value.
I believe we were successful at reaching a broad cross-section of the markets represented on the Consultative Committee, especially in light of the short 2-week turn around time that we requested. (Two-week turnaround was also during a time of extreme difficulty and challenge for all markets as a result of terrorist attacks.) We heard from 15 market authorities — the term we use to describe exchanges and organized OTC markets — located in 11 different jurisdictions, some from emerging market countries and others from countries with more developed markets. The responding markets range from the Australian Stock Exchange, Istanbul Stock Exchange, Japan Securities Dealers Association, Kuala Lumpur Stock Exchange, London International Financial Futures Exchange, New York Stock Exchange and the Swiss Exchange. A complete list of the market authorities that responded to the survey is included at the end of the written materials.
Before turning to an overview of the survey responses, I want to note that the members of the Consultative Committee have not had an opportunity to discuss their views on trading halts with one another to see if they could arrive at a common understanding where differences of opinion may exist. Accordingly, we are not making any recommendations at this time regarding acceptable practices. We may undertake that task at our mid-year meeting scheduled for late January 2002. We are also interested in working closely with Standing Committee 2 on any follow-up initiatives you may decide to undertake regarding trading halts.
I would now like to provide a summary of the views that we received from the 15 markets that responded. The survey was organized into two main parts. The first part posed questions regarding the use of trading halts as a regulatory tool to manage actual or anticipated periods of extreme market volatility due to unusual or extraordinary events or conditions. The questions cover rule based trading halts, such as halts that occur as the result of circuit breakers, and trading halts imposed on an ad hoc basis in response to specific events.
The second part of the survey posed questions regarding information-based trading halts. This type of trading halt is intended to allow for the dissemination of important information about a security or the security's issuer that could influence the prices at which the security trades.
I am focusing my remarks on trading halts as a regulatory tool to manage extreme market volatility, where the issues are more complex and differences of opinion are more pronounced. The issues surrounding information based trading halts are fairly straightforward and appear to be non-controversial. I refer you to the written materials for a summary of the responses regarding information-based trading halts.
The first set of questions asked who has the authority to impose trading halts in response to or in anticipation of extreme market volatility or market disruption, and who should make that decision.
All but one of the responding markets (the Taiwan Stock Exchange) stated that they have the authority to impose a trading halt in their markets, and expressed the view that the primary responsibility should rest with them. Because the market authorities provide the market facilities, they have access to the necessary information to make quick, informed decisions. Many also noted that their regulators also have the authority to issue trading halts, and recognized the value of cooperation between the market authorities and the government regulators.
The second set of questions asked respondents to describe the circumstances under which trading halts should be implemented and the types of factors that should be taken into account to arrive at such a decision.
Many identified physical emergencies as events that could, depending upon magnitude, cause trading to halt. Examples of physical emergencies include system failures, natural disasters such as floods or earthquakes, and acts of war that adversely impact a market's operating, including trading, clearing and telecommunication links. The suspension of trading at the Istanbul Stock Exchange following the 1999 earthquake in Turkey and suspension of trading in United States stock markets following the September 11th attack on the World Trade Center are events that come to mind. The concern is whether the emergency event fundamentally impairs the market's ability to function, and not market volatility per se, although market volatility can be a by-product of a physical emergency.
There is a split of opinion, however, on the more difficult issue of whether trading halts should be used to try to manage extreme market volatility, whether on an ad hoc basis or on a rule basis such as through the use of circuit breakers or price limits. Those who believe trading halts are an effective regulatory tool emphasize that they should be used cautiously and that markets should try to remain open as much as possible. Others believe that the disruption caused by trading halts outweigh their potential value. I will come back to this debate shortly.
Most of the responding markets have circuit breakers in place. The Athens Stock Exchange and Kuala Lumpur Stock Exchange do not, but are considering plans to adopt them. The Australian Stock Exchange and SFE also do not have circuit breakers, and are opposed to adopting them in their markets.
The third set of questions relate to the reopening of trading following a trading halt. Not surprisingly, the general view and practice is that the market authorities should decide when to resume trading in their markets. A common theme is that markets should try to reopen as soon as the reasons giving rise to the trading halt are addressed or fair and orderly trading can be resumed. Interestingly, most respondents did not cite any difficulties reopening their markets after a trading halt.
Now we come back to the debate on whether trading halts, including circuit breakers, are an effective regulatory tool for managing extreme volatility or market disruption, whether actual or anticipated, to promote fair and orderly markets. The fourth set of survey questions cover this ground.
Many of the markets that responded believe that trading halts, used carefully, help protect investors during turbulent markets, by protecting investors from large rapid price declines through a cooling off period. The cooling off period is thought to help abate investor panic.
Others strongly oppose the use of trading halts as a tool to manage volatility or anticipated volatility, citing harm to the markets and to investors who are prohibited from closing out open positions or implementing risk management strategies. The Australian Stock Exchange, for example, offered multiple reasons why it believes that market-wide trading halts should not be imposed as a response to volatility or anticipated volatility. These include the concerns that "Trading halts compromise the credibility of the exchange as an accessible market," "impede trading and hedging strategies and lock investors into positions involuntarily" and "interfere with self-correcting forces that bring the market back to equilibrium."
Another market, the SFE Corporation (formerly the Sydney Futures Exchange) offered anecdotal evidence that trading halts are an unnecessary response to unusual or extraordinary events that are likely to cause market volatility. The Exchange specifically considered and rejected the idea of suspending trading in its markets following the events of September 11, noting that "Trading, while volatile, was conducted in a fair, orderly and transparent manner."
The markets that question the value of trading halts also suggest that other types of regulatory responses may be adequate, such as heightened market surveillance and reminding large market participants of the obligations to conduct their trading activities in a fair and orderly manner.
The last two sets of questions relate to parallel trading halts and the value of coordination among markets and government regulators when trading halts across related markets are under consideration.
Views differed on the need for parallel trading halts based upon the respondent's perspective as a securities or derivative market.
Those that operate securities markets generally expressed the view that if trading is halted in a security or group of securities, it should be halted in the markets for related derivatives products. Some derivatives exchanges, in contrast, expressed the view that a trading halt in the underlying securities should not automatically cause trading to halt in derivatives based on those securities, noting that it may be more beneficial to market users if the related derivatives markets are kept open so that investors have a means to manage the risks associated with their securities positions during the period of market turbulence.
One derivatives exchange addressed the issue of stock index products. The Chicago Board of Trade expressed the view that trading of broad-based stock index futures should not be halted as a result of a trading halt in the underlying securities unless trading is halted in all of the underlying securities. In the case of narrow-based stock index futures, it advocates a test under which trading in the stock index future would only be halted if it is halted in securities comprising at least 50% of the market capitalization of the index.
Finally, on the topic of coordination, the respondents generally recognize the value of cooperation and coordination across affected markets and with government regulators. Some respondents also highlighted the value of consulting with market participants and issuers, as well.
There is no clear consensus on whether there is a need for formal coordination and cooperation mechanisms. Some respondents follow informal procedures and believe they are adequate; others would prefer more formal procedures and others have formal procedures in place. At a minimum, contact lists of who to call at other market authorities would seem to be beneficial.
To summarize, the issues surrounding trading halts are of strong interest to many members of the Consultative Committee. They deal with trading halt issues first hand, and believe they should have primary responsibility for deciding when to halt trading in their markets and when to reopen trading.
There are divergent opinions as to whether trading halts should be used as a tool to manage actual or anticipated periods of extreme market volatility. Similarly, not all markets have circuit breakers, and some oppose their use. In any event, the general consensus seems to be that markets should try to stay open as much as possible and, accordingly, should use trading halts only in extreme circumstances and should lift them as soon as circumstances allow. It may be appropriate to do a quantitative study to analyze the impact of trading halts on market volatility.
There is also general recognition of the value of open communications and cooperation among market authorities and government regulators when parallel trading halts are under consideration.
Although I have not addressed the use of "information-based" trading halts in my remarks, I do want to note that there is general support for the use of such trading halts to permit dissemination of material information about the securities or the securities' issuer when such information is not generally known. Trading halts under these circumstances are thought to protect investors by providing them with access to information that may influence their trading decisions.
I want to thank you again for requesting the Consultative Committee's input on this important topic. As I explained earlier, the Consultative Committee is not making any formal recommendations at this time regarding acceptable practices. We would like to work closely with the Standing Committee in any follow-up project it may undertake to develop such standards. The Consultative Committee will likely address the issues surrounding trading halts at our up-coming mid-year meeting, scheduled for January 2002. Therefore, if there are any areas that you would like further study or new issues to be addressed, the Consultative Committee continues to offer its assistance to further the study on this important topic.