The prolonged shutdown of trading in NASDAQ listings last week foreshadows rising costs for exchange firms, says Moody’s Investors Service in a new report.
The rating agency says that last week’s three-hour trading suspension “is the latest evidence that the demand being placed on the U.S. securities trading infrastructure is outpacing the functionality of the controls and technologies that support it.”
Moreover, it suggests that regulators’ commitment to reduce this risk “seems certain to significantly increase exchange operators’ compliance and technology costs”; which represents a credit negative for those firms.
“The longer-term consequences for the exchanges and other market participants will depend on the extent to which processes and technologies improve to meet participants’ diverse and often complex needs,” it says; adding that the impact will also depend on “the extent to which regulators determine that the existing market structure needs to be reformed or scaled back because of technological limitations.”
Moody’s places last week’s unexplained technical failure at the NASDAQ as the latest in a series of high-profile issues that have occurred over the past few years in U.S. markets, including the “flash crash” of 2010; problems with the initial public offerings of Facebook, Inc. and BATS Global Markets, Inc. in 2012; and the two-day market shutdown due to Hurricane Sandy last year.
This latest disruption spurred the head of the U.S. Securities and Exchange Commission (SEC), Mary Jo White, to say she would advance SEC proposals to beef up its standards for various market participants, including exchanges and alternative trading systems.
“Increased regulatory scrutiny and higher compliance and technology costs would be credit negative for exchanges and execution venues, especially in an increasingly competitive environment with shrinking market volumes and reduced profit margins,” Moody’s says.
Tougher controls could also benefit traditional exchanges, it says, “if it resulted in a more stable marketplace with reasonable ongoing compliance costs.”
However, Moody’s warns that the unknown factor, which could significantly affect the industry, is the regulatory treatment of high-frequency trading (HFT) firms. If regulators determine that HFT is one of the causes for these technical breakdowns, and moves to curtail this activity, Moody’s says this would result in further reductions in trading volumes, which would negatively affect the exchanges’ creditworthiness.
Last week’s disruption is also particularly negative for NASDAQ, the report says, adding that, “recurring issues of this nature could weaken franchise value and lead to enhanced regulatory scrutiny and additional fines.”