The Investment Industry Regulatory Organization of Canada (IIROC) has published the final guidance on its approach to intervening to ensure fair and orderly markets in the case of so-called “fat finger” trades, or other clearly erroneous trades.
On Monday, IIROC published a final version of guidance that was proposed earlier this year to set out the circumstances in which the regulator may use its discretion to vary or cancel unreasonable trades. “The guidance is intended to provide transparency and greater certainty respecting the criteria for discretionary regulatory intervention,” it says.
Efforts to clarify the terms of regulatory intervention came in the wake of the “flash crash” in May 2010, when regulators stepped in after extreme volatility produced some highly unusual trading activity. This latest guidance is intended to operate in conjunction with various other measures implemented since then to help control short-term, unexplained price volatility, including: guidance on best execution and using certain order types, single stock circuit breakers, and new rules on electronic access; and measures, that are still under consideration, such as marketplace thresholds, and revised market-wide circuit breakers.
The guidance indicates that IIROC may intervene when trades are “unreasonable” due to material information being known by certain traders that hasn’t been publicly disseminated, or due to an unintentional ‘erroneous’ trade; or, when the trading is not in compliance with the trading rules.
Under the guidance, the discretion of an IIROC official to vary or cancel a trade is subject to guidelines that include a ‘no touch zone”, which provides that there will no regulatory intervention when the price difference between an “erroneous” trade and the current fair value of the security does not exceed the greater of 10% of the price of the security or 10 trading increments. A higher threshold may be used when the trade has been executed during a period of significant market volatility, outside normal trading hours, or in a security of limited liquidity.
It also describes limited conditions under which regulatory intervention to cancel an ‘erroneous’ trade would be considered, such as: extreme price dislocation when there would be no reasonable expectation of execution, or a trading error that does not impact market price but places the issuer at risk.
IIROC stresses that market forces should generally drive trading activity without regulatory interference, and says that regulatory intervention is reserved for circumstances when market integrity is at risk and it is necessary to maintain orderly markets. Trades will not necessarily be varied or cancelled only to fix an error of a client or trader if it does not impair market integrity.
In response to comments received on the proposed guidance, IIROC has made amendments to provide flexibility in the application of the “no touch zone”; broadening the discretion to apply a higher threshold in the case of a trade involving a security of limited liquidity; and clarifying that, in the case of a trade resulting from the entry of an order that does not comply with trading rules there is no pre-determined price threshold that must be met before IIROC can intervene, or commence regulatory enforcement proceedings.