Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Parochialism of national and global exchanges

I blogged three years ago about how Indian exchanges pretend to be national in their scope, but shut down when conditions in their home city make it convenient to take a holiday. Their equally parochial regulators are also complicit in this. (I have been critical of the 9/11 closures in the US as well).

This week as hurricane Sandy hit the east coast of the US, it was the turn of the big US exchanges with global footprints to reveal their parochialism. Their regulator was also happy to endorse the decision of these exchanges to shut down. It was left to a former Chairman of the US SEC, Arthur Levitt to state the obvious:

If you’re going to have a stock exchange, it should have a backup facility of some sort so that regional events don’t cause its closure, … This should not happen to the world’s most prominent exchange.

The response of the NYSE CEO was that Arthur Levitt “maybe a little out of date with the facts.” No it is the exchanges and their regulators who are out of date with the facts – somebody forgot to tell them that modern exchanges are not trading floors subject to the vagaries of the local weather, but electronic networks which can be rerouted very easily. And no, the difficulty of New York brokers to get to their offices is no excuse for shutting the national exchange. By this logic, they should have shut the NYSE when hurricane Katrina struck New Orleans; surely, brokers based there would have had great difficulty reaching their offices.

In my experience, backup sites in the financial industry are a big joke. Typically, these systems are set up only to satisfy check box ticking regulators who require them to have back up sites, but do not bother to check whether these are actually adequate. Many of these backup systems have significantly less processing capacity than the main site. Moreover, they are not designed to run the full suite of software that runs on the main system. Given the willingness of spineless regulators worldwide to shut down national financial market places at the drop of a hat, this reluctance to spend money on genuine backup sites is fully rational.

I am convinced that regulators should simply force each institution to operate out of its backup site on a few random days each year. They should get very minimal notice (otherwise, they would fly down their entire management team to the backup site to make it work). Accountable algorithms that I blogged about recently are ideal to ensure that the dates are indeed randomly chosen.

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2 responses to “Parochialism of national and global exchanges

  1. anon4cec November 4, 2012 at 11:00 am

    “And no, the difficulty of New York brokers to get to their offices is no excuse for shutting the national exchange. By this logic, they should have shut the NYSE when hurricane Katrina struck New Orleans; surely, brokers based there would have had great difficulty reaching their offices.”

    But isn’t the difficulty here (for the NYSE that is) related to designated market makers based in NY? You might have an issue with the DMM system itself, but given that’s how trading occurs on the NYSE platform, does NYSE have an option?

    • Jayanth Varma November 5, 2012 at 10:48 am

      Either the DMMs are an essential part of the market infrastructure (the exchange cannot function without them) in which case the same disaster recovery and backup site rules that apply to the exchange should apply to them. Or, the DMMs are “nice to have” but not “cannot do without” in which case, the exchange should be able to run without them.

      My understanding is that the latter is perhaps closer to reality since NYSE’s backup plan apparently involves shifting everything to NYSE Arca whose competing market makers are clearly in the “nice to have” category since the electronic order book can run without them (though with reduced liquidity).

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