New Measures to Address Market Volatility
July 1, 2012
Investor Bulletin: New Measures to Address Market Volatility
The updated version of this bulletin includes new implementation dates for the program and new hyperlinks to recent changes in the program
The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to inform investors of recent safeguards approved by the SEC to address market volatility in U.S. equity markets. On May 31, 2012, the SEC approved a new “Limit Up-Limit Down” mechanism to address market volatility by preventing trades in listed equity securities when triggered by large, sudden price moves in an individual stock. Additionally, the SEC approved proposed rule changes that modify existing circuit breaker procedures related to market-wide trading halts.
Background on Single-Stock Circuit Breakers - In June 2010, the Commission approved on a pilot basis procedures for single-stock circuit breaker trading pauses for five minutes if a stock’s price moves up or down sharply in a five-minute window. U.S. exchanges and the Financial Industry Regulatory Authority (FINRA) proposed these procedures in response to unusually volatile trading on May 6, 2010, that affected a large number of individual securities but was not broad enough to trigger the existing market-wide circuit breakers. These circuit breaker rules were initially applied only to stocks in the S&P 500 Index but were extended on a pilot basis to all National Market System securities in June 2011.
New Limit Up-Limit Down Mechanism - On May 31, 2012, the Commission approved a “limit up-limit down” mechanism to replace the single-stock circuit breaker rules. Because single-stock circuit breakers are triggered after a trade occurs at or outside of the applicable percentage threshold, circuit breakers have been triggered by erroneous trades. In contrast, the new limit up-limit down mechanism is intended to prevent trades in individual securities from occurring outside of a specified price band. This price band would be set at a percentage level above and below the average price of the stock over the immediately preceding five-minute trading period. These price limit bands will be 5%, 10%, 20%, or the lesser of $.15 or 75%, depending on the price of the stock. Additionally, these price bands will double during the opening and closing periods of the trading day. If the stock’s price does not naturally move back within the price bands within 15 seconds, there will be a five-minute trading pause.
This new “limit up-limit down” mechanism will be implemented in two phases. The first phase will apply the limit up-limit-down mechanism to all stocks in the S&P 500 and Russell 1000, and to select exchange traded products. This first phase will commence on April 8, 2013. The second phase of the implementation will apply the “limit up-limit down” mechanism to all remaining National Market System securities and will commence on October 8, 2013.
Revised Market-Wide Circuit Breakers - The securities and futures exchanges have procedures for coordinated cross-market trading halts if a severe market price decline reaches levels that may exhaust market liquidity. These procedures, known as market-wide circuit breakers, may halt trading temporarily or, under extreme circumstances, close the markets before the normal close of the trading session.
Under the revised rules approved by the SEC, market-wide circuit breakers will provide for cross-market trading halts during a severe market decline as measured by a single-day decrease in the S&P 500 Index. A cross-market trading halt can be triggered at three circuit breaker thresholds—7% (Level 1), 13% (Level 2), and 20% (Level 3). These triggers are set by the markets at point levels that are calculated daily based on the prior day’s closing price of the S&P 500 Index.
A market decline that triggers a Level 1 or Level 2 circuit breaker before 3:25 p.m. will halt market-wide trading for 15 minutes, while a similar market decline “at or after” 3:25 p.m. will not halt market-wide trading. A market decline that triggers a Level 3 circuit breaker, at any time during the trading day, will halt market-wide trading for the remainder of the trading day.
These revisions to the market-wide circuit breakers will be implemented on February 4, 2013. Until then, market-wide circuit breakers will continue to operate under the old market-wide circuit breaker rules which use: circuit breaker thresholds of 10% (Level 1), 20% (Level 2), and 30% (Level 3); and the Dow Jones Industrial Average as the reference index to measure daily market declines.
For additional information about the new limit up-limit down mechanism, and the revised market-wide circuit breakers, please read the following: