The American Stock Exchange Inc. supports uniform circuit breakers across all U.S. securities and futures markets, and believes that the markets and investors would benefit from circuit breakers triggered under extraordinary market conditions. Uniform, market-wide circuit breakers merely formalize the market's tendency to interrupt trading when few or no natural buyers or sellers are present to absorb contra-side market interest. Because market stresses in particular segments of the market can easily spill over into other segments, it is appropriate to build in the uniform, predictable coordination among markets that formal circuit breakers provide.
The type of markets we experienced on October 27, 1997, when circuit breakers
were triggered for the first time, was a clear indication that the current thresholds are too
low, and we believe there is complete consensus that circuit breaker point levels must be
raised, with discussion centered on where those levels should be reset and the duration of
the halts that are triggered. We fully support a significant expansion of the current 350
and 550 point parameters. The 10 percent and 20 percent thresholds based on declines in
the Dow Jones Industrial Average that are currently being discussed are comparable to
those in effect in October 1988. We believe they have the advantage over current
thresholds of being flexible (allowing for periodic reset based on future fluctuations in the
Dow Jones Industrial Average), easily understood by the public, and reflecting an
extraordinary market decline, rather than a significant but manageable correction.
We understand the opposition of some market participants to any circuit breaker
mechanism in a free and open marketplace. Indeed, as both an equity and an options
exchange, the Amex itself must balance the sometimes diverse opinions of those on the
different sides of its business. While there is a need for a consensus "solution" to the
problem of when a market-wide halt should occur, any solution will be imperfect from
the perspective of some market participants. We believe on balance, however, that
coordinated trading halts in times of extraordinary market decline best serve the public
investors that remain the bedrock of our markets. The subject, of course, will continue to
be assessed by all markets to ensure that market-wide halts are in the public's best
interest.
My name is James Duffy, and I am Executive Vice President and General Counsel of the American Stock Exchange. It is my pleasure to share with the Subcommittee the Exchange's views on circuit breakers. We come to this issue from the unique perspective of the only U.S. exchange that is both a primary market for listed equity securities , as well as a market for equity options, index options and equity derivatives.
The Amex supports uniform circuit breakers across all U.S. securities and futures markets. The reasons justifying market wide trading halts, originally articulated in the 1988 reports by both the President's Working Group on Financial Markets and the Brady Task Force following the October 1987 market break, remain persuasive today. Circuit breakers are intended to reduce panic selling to allow markets to publicize sell order imbalances in order to attract potential buyers, and to provide regulators and broker- dealers an opportunity to assess capital positions. Moreover, as the Brady Task Force observed, circuit breakers reflect "the natural limit to intermarket liquidity" and they counter any "illusion of liquidity"; that is, they make formal what should be obvious - that markets have an inherently limited capacity to quickly absorb massive, one-sided volume. Indeed, even without formal circuit breakers, trading in stocks that are subject to extraordinarily intense selling over short periods would most likely be halted because of extreme order imbalances. Natural circuit breakers, therefore, are inevitable; uniform, market-wide circuit breakers merely formalize the market's tendency to interrupt trading when few or no natural buyers or sellers are present to absorb contra-side market interest.
Circuit breakers, in themselves, are not aberrational or extraordinary. When formal circuit breakers, set at appropriate levels, are triggered, it is likely that a sizeable segment of the market would have halted anyway. In addition, market stresses in particular segments of the market can easily spill over into other segments. This requires the uniform, predictable coordination among markets that formal circuit breakers provide.
The critical purposes of circuit breakers have never been fully tested since their implementation in October 1988. The type of markets we experienced on October 27, 1997, when circuit breakers were triggered for the first time, was a clear indication that the current thresholds are too low. In October, 1988, market moves of 250 and 400 points represented moves of approximately 12 percent and 19 percent, respectively, in the Dow Jones Industrial Average. Last October 27, the 350 and 550 point parameters, which all markets raised from original point levels in January 1997, represented moves in the Average of about 4.5 percent and 7.2 percent, respectively, far below comparable 1988 levels.
We believe there is complete consensus that circuit breaker point levels must be raised, with discussion centered on where those levels should be reset and the duration of the halts that are triggered. The trading we observed on the Amex on October 27, 1997, demonstrated that a market break of 550 points, while clearly significant, did not implicate the issues that circuit breakers are intended to deal with. The Amex's equity and options order routing systems operated effectively throughout the October 27 market decline as well as at the opening on October 28. Prior to the 350-point trigger at 2:35 p.m. no Amex equities had been halted because of order imbalances. After the re- opening at 3:05 p.m., stocks re-opened promptly and in an orderly manner, with no gaps in pricing that would trigger the need for Exchange specialists to disseminate a price indication. Seventy-five percent of Amex equities opened within five minutes of the reopening, ninety-five percent opened within ten minutes and ninety-eight percent within fifteen minutes. Likewise, equity and index options re-opened in an orderly manner, generally within 15 minutes following resumption of trading of the underlying equities on the New York Stock Exchange, the Amex or Nasdaq. Of course, Amex, like other markets, has implemented significant systems upgrades since the 1987 break to increase systems capacity and to enable Exchange order-routing and execution facilities to handle dramatic spikes in transaction and quotation traffic, such as can be expected during serious market declines. The Exchange, like other markets, also increased minimum capital requirements for Amex specialists in part to cushion against rapid declines in available market making capital during stressed market conditions. Such measures enabled Exchange members to efficiently execute all orders on October 27, 1997; in fact the 554 point decline in no way tested the limits of Exchange systems under stress. We remain committed to continuously upgrade systems to avail ourselves of state-of-the-art technology.
It is generally acknowledged that the October 1997 decline did not constitute the panic selling or extraordinary market conditions warranting a market-wide halt, as envisioned in 1988 by market overseers. Securities and futures exchanges have been engaged in ongoing discussions with the SEC to effect changes to circuit breaker procedures that are effective and measured. We fully support a significant expansion of the current 350 and 550 point parameters. The 10 percent and 20 percent thresholds based on declines in the Dow Jones Industrial Average that are currently being discussed are comparable to those in effect in October 1988. We believe they have the advantage over current thresholds of being flexible (allowing for periodic reset based on future fluctuations in the Dow Jones Industrial Average), easily understood by the public, and reflecting an extraordinary market decline, rather than a significant but manageable correction.
The Amex understands the opposition of some market participants to any circuit breaker mechanism in a free and open marketplace. Indeed, as an equity and an options exchange, the Amex itself must balance the sometimes diverse opinions of those on the different sides of its business. While there is a need for a consensus "solution" to the problem of when a market-wide halt should occur, any solution will be imperfect from the perspective of some market participants. Many market makers, particularly those in centralized auction markets, would probably prefer the formality of a circuit breaker- imposed halt, rather than deal simultaneously with an extraordinary number of less formal trading imbalances, which would have the practical effect of halting trading in many stocks. Indeed, we believe there would be a number of those who would prefer thresholds lower than 10 percent and 20 percent. Options specialists on the other hand, and market makers in derivatives generally, could be expected to prefer that the market be kept open or be re-opened following a halt late in the trading day, particularly on Expiration Fridays- the last day on which certain options contracts can be exercised. In contrast, listed companies could be expected to be concerned with a free-fall in their stocks and would view circuit breakers in a positive light. We also believe public investors would be comforted by appropriate circuit breakers and would not generally view them as indicative of market inefficiency.
The difficult practical questions to some extent are in the details, such as the appropriate duration of coordinated trading halts. Particularly significant for us as an options market are the questions surrounding trading towards the end of the day. Options holders must decide whether or not to liquidate or change positions, decisions that become particularly important on the day an option will expire. Because those decisions can be so critical, it is of special importance that investors be aware of the time within which they must make their decision. Since properly calibrated circuit breakers will be triggered only on rare occasions, we have a concern that investors may not focus on the fact that an early close can accelerate the point by which they must make an investment decision. If our market rules are structured to maximize the opportunity for there to be a normal 4:00 p.m. close, we believe that options holders are best served. Accordingly, since markets take some time to reopen following a circuit breaker halt, there is a point towards the latter part of the trading day at which we believe it is better to remain open for such trading as can still occur rather than impose an early close triggered by the movement in the Dow, at least when the issue is a ten percent drop. We do recognize that a downward move of twenty percent is so extraordinary and so severe as to suggest that it is very likely that few stocks will be able to be opened or remain open to a "natural close", so we can much more readily understand the view that a close for the day at that point is the preferable alternative.
Whatever the "solution", the question will likely remain, is it preferable to allow
stocks that can trade to continue to trade, while a number of issues are halted due to order
imbalances, or to accept other problems that may be associated with an early closing?
Any answer will not be totally satisfactory to all participants. The area, of course, will
continue to be assessed by all markets. Developments such as increased trading abroad in
U.S. securities will have to be considered to ensure that market-wide halts are in the
public's best interest. Nevertheless, we believe, on balance, that the markets and
investors would benefit from circuit breakers triggered under extraordinary market
conditions.
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