Updating the Market-Wide Circuit Breaker

Remember the 1987 stock market crash? The most significant regulatory response to that event was to establish a market-wide circuit breaker in 1988, which halts the market if it falls at least 10% (see table at bottom). The halt closes all US markets, including equities and derivatives.

You may not even know this market-wide circuit breaker exists. It has only been triggered one day (October 27, 1997) in 23 years. When the Dow fell 9.2% on May 6, 2010 (the “Flash Crash”), it was not a large enough decline to trigger a halt.

Working with exchanges and FINRA, the SEC has implemented several regulatory responses to address the "Flash Crash" (single-stock circuit breakers, market maker obligations, market access rules, limit up-limit down coming soon) and modernizing the existing market-wide circuit breaker is another change underway.

Assuming the proposal is approved, here are the key changes to the existing market-wide circuit breaker:

§  The DJIA index (30 stocks) will be replaced with the S&P 500 index. The broader S&P 500 Index, which correlates closely with derivative products like e-minis and SPX, will allow for a better cross-market measure of market volatility.

§  The markets will be halted based on a decline of 7% rather than 10%. Using the lower percentage level, the proposed circuit breaker would have halted the market 10 times since 1988, including May 6th and 5 days in October 2008 after Lehman Brother’s collapsed. The proposal also reduces the Level 2 percentage to 13% from 20%, and the Level 3 percentage to 20% from 30%.

§  The percentage decline calculation will be based on the change from previous day’s close vs. the last month of quarter average to ensure the triggers relate to current market conditions.

§  The halt time will be shorter, only 15 minutes vs. 30, 60, or 120 minutes. This will help to minimize market disruption and reflects the increased speed of trading in the market. One exception is a Level 3 move will halt the market for the rest of the day.

§  Simplify the time when the trading halt is triggered from six to two relevant time periods. Look at the various time periods in the existing rule in the table below. Under the current rule, a Level 1 halt cannot be triggered after 2:30 p.m., which was a factor on May 6th, when the market fell significantly around 2:42 p.m. Under the new proposal, a 15-minute halt can be triggered up to 3:25 p.m. Pretty straightforward.

Here is a SEC link on the proposal.

Current Rule 80B Circuit Breaker Levels for Fourth Quarter 2011

Level 1 Halt @ 10% - 1,100 DJIA points

Before 2:00 p.m. – 1 hour

2:00 to 2:30 p.m. – 30 minutes

At or after 2:30 p.m. – no halt unless there is a level 2 halt

Level 2 Halt @ 20% - 2,250 DJIA points

Before 1:00 p.m. – 2 hours

1:00 to 2:00 p.m. – I hour

At or after 2:00 p.m. – halt and not resume

Level 3 Halt @ 30% - 3,350 DJIA points

At any time - halt and not resume

Average closing DJIA values in the most recent month:  11,175.45


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