Stock exchanges began the year with praise for their resilience during the pandemic turbulence but are ending it with their reliability under scrutiny.
A series of high-profile outages in the second half of 2020 has put the spotlight on operators of the financial infrastructure that underlies global markets. The bumpy end of the year marks a stark contrast to the spring, when exchanges were commended by regulators for withstanding an unprecedented surge of activity at the height of the March ructions.
The glitches have underscored global authorities’ mounting concerns that the reliance across markets on technology and automation to buy and sell assets at the blink of an eye is creating a risk to the financial system.
Regulators in the EU, UK and Singapore want to tighten standards for banks, exchanges, clearing houses and payments providers, to withstand the effects of pandemics, cyber events, natural disasters and technology failures. The Bank for International Settlements, which coordinates work globally for the banking industry, is planning to create its own standards.
The matter has taken on more urgency over the past few months. Germany’s main market, Deutsche Börse’s Xetra in Frankfurt, was hit by repeated technical failures this year that took out share trading across several European countries. Tokyo Stock Exchange endured in October its worst-ever outage, prompting the chief executive to resign a month later.
The glitch in Japan was followed by the failure of the critical closing auction at Euronext, which runs six exchanges across Europe including the main Paris bourse. Traders were left in the dark on the closing prices for shares, derivatives and bonds for hours while the knock-on effects in clearing and warrants took several days to resolve.
“The reasons for these outages have varied but their impact on market and regulator confidence can’t be understated,” said Virginie O’Shea, founder of Firebrand Research, a London consultancy. “In a different year these events might not have been as visible and quickly forgotten, but the unique conditions of this year have exacerbated their impact.”
Exchanges showcased their best qualities in March as global markets dropped with dizzying speed. They provide the peg against which rivals, such as private markets like ‘dark pools’, benchmark their prices. At its peak, the New York Stock Exchange had more than 100bn messages of orders and quotes passed across its systems, nearly three times its previous highest record, but consumed only 50 per cent of its computing capacity. Unlike at banks, there was no backlog of trades.
But exchange operators’ systems require constant upgrading to keep pace with their customers’ demands. They often rely on third parties to supply crucial hardware and software, leaving them vulnerable to unexpected issues.
Nandini Sukumar, chief executive of the World Federation of Exchanges, the global industry group, said operational resilience continued to be a priority for the industry.
“Inevitably there will be outages and glitches but the industry always solves the problems and moves forward,” she said. “Every challenge or outage is also an opportunity to think about whether there’s something that can be done better.”
Even so, some traders and investors have said they are frustrated by what they see as lacklustre responses by some exchange operators to outages.
“This is a fundamental issue for the buyside trading desks and it needs to be urgently addressed. A clear, robust back-up plan needs to be in place to ensure an efficient marketplace going forward,” said Anita Karppi, managing director of K & K Global Consulting, which runs a network for traders in fund management to discuss industry issues.
The problem is particularly acute in Europe where Euronext and Deutsche Börse own or supply technology to the primary exchanges of more than a dozen countries. An outage can disrupt trading across multiple markets.
There is also mounting dissatisfaction among some trading executives and market markers that investors do not use alternative venues or dark pools to circumvent outages.
“It highlights important systemic fragilities in the European capital markets that should be addressed,” said Edward Monrad, head of European equity market structure at Optiver Europe, a Dutch market maker.
Companies such as CBOE Europe, Turquoise and Aquis Exchange typically take up to 40 per cent of market share in a normal day, but trading on their markets also dries up when the primary exchange goes down.
Optiver pointed out that many of the brokers’ trading algorithms are tied to the prices on the primary exchange and not the pan-Europe market. EU regulations compound the issue by allowing investors to make large block trades at alternative venues, but then still compelling them to price them in line with the primary exchange.
“It’s frustrating but this gives the industry the impetus to find improvements and enhancements,” said David Howson, president of CBOE Europe.
Like many others, Mr Howson pointed out the merits of the US system, which allows orders normally sent to a stricken exchange to be traded on rival marketplaces. In 2015, a three-hour outage on the NYSE left the markets unaffected as rivals Nasdaq and CBOE Markets, as well as investment banks, scooped up business.
But Europe is a patchy mixture of cross-border and local trading. National primary exchanges often have a broader membership, drawing in big and small brokers and activity from retail share trading platforms. They also have different memberships, rule books and settlement procedures.
Furthermore, investors also benefit from the so-called “public good” that derives from centralising critical parts of trading.
For example, investors are happy to trade on different venues on a normal day, but they prefer to direct their business back to the exchange at the close. It provides a single final price of the day, and is used as the benchmark for valuations of thousands of share and derivatives portfolios.
That leaves many market participants back where they started — dependent on one critical cog in the machine, and frustrated when it breaks.
“I think the time has come for the regulator to mandate more stringent practices, such as standardisation of response,” said Paul Squires, head of European, Middle East and Africa trading at fund manager Invesco.
Ms Sukumar also supported a system-wide approach. It “avoids the negative unforeseen consequences of focusing on particular sectors while others have not been subject to appropriate scrutiny,” she said.