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In another example of “market modernization,” 23/5 trading is coming to US markets whether you like it or not – here are a couple of blogs about the SEC’s recent 24-hour trading roundtable. With December 6th only two months away, listing exchanges are continuing to update rules and procedures to accommodate extended overnight trading.

Yesterday, the SEC posted notice of this automatically effective Nasdaq rule change to the exchange’s market-wide circuit breaker procedures, which hopefully gives some comfort that the overnight session will not be a complete free-for-all. Here’s an excerpt:

The MWCB mechanism under Equity 4, Rule 4121 provides an important, automatic mechanism that is invoked to promote stability and investor confidence during a period of significant stress when U.S. securities markets experience extreme broad-based declines. All U.S. equity exchanges and the Financial Industry Regulatory Authority (“FINRA”) (collectively, the self-regulatory organizations or “SROs”) adopted uniform rules relating to the MWCB mechanism in 2012, which are designed to slow the effects of extreme price movement through coordinated trading halts across U.S. securities markets when severe price declines reach levels that may exhaust market liquidity.5 Currently, market-wide circuit breaker rules provide for trading halts in all U.S. cash equities and equity options markets during a severe market decline as measured by a single-day decline in the S&P 500 Index during Regular Market Hours.

Pursuant to Equity 4, Rule 4121, a market-wide trading halt will be triggered if the S&P 500 Index declines in price by specified percentages from the prior day’s closing price of that index. Currently, the triggers are set at three circuit breaker thresholds: 7% (Level 1), 13% (Level 2), and 20% (Level 3). A market decline that triggers a Level 1 or Level 2 halt after 9:30 a.m. ET and before 3:25 p.m. ET would halt market-wide trading for 15 minutes, while a similar market decline at or after 3:25 p.m. ET would not halt market-wide trading. If a Level 3 Market Decline occurs at any time during the trading day, trading in all stocks will halt on the Exchange for the remainder of the trading day and will resume the following trading day at 4:00 a.m. ET during the Pre-Market Hours Session.

In light of the move to 23/5 trading, Nasdaq (and other SROs) are proposing to preserve downtime when a Level 3 Market Decline is triggered. The notice states:

The MWCB mechanism described in Equity 4, Rule 4121 is an important, automatic mechanism that is invoked to promote stability and investor confidence during periods of significant stress when U.S. securities markets experience extreme broad-based declines. The proposed rule change would ensure that the Exchange’s resumption time following a Level 3 halt continues to apply when the Exchange and various other U.S. equities exchanges begin trading on a 23-5 basis, notwithstanding current rule text implying that the resumption time would coincide with the start of overnight trading on the Exchange.

Rather than leave the rule in place as is, which could result in an earlier resumption time than originally contemplated when the rule was adopted, the Exchange, the other U.S. equity exchanges, and FINRA met alongside industry representatives to determine the appropriate resumption time. Following those discussions, the Exchange determined, in coordination with other SROs, to retain a morning resumption time, notwithstanding the fact that an earlier resumption time would be possible with the introduction of 23-5 Trading. The proposed rule change codifies this decision into the Exchange’s rules. The Exchange understands that the other SROs will also be filing similar proposed rule changes. As a result, the market as a whole, including on- and off-exchange, will continue to be subject to harmonized rules for the resumption of trading following a Level 3 Market Decline.

The notice goes on to explain that while the SROs had previously decided to tie the resumption time following a Level 3 halt to an SRO’s normal hours of operation, the upcoming transition to 23/5 Trading raises various concerns that warrant a change from the current approach. For example:

– First, the MWCB mechanism was designed to provide a cooling off period where market participants would be provided with additional time to evaluate the market events that led to the decline before determining how to position their trading activity for the next day. With the introduction of 23-5 Trading and the start of the Night Session at 9:00 p.m. ET, however, this cooling off period could be materially shortened, reducing one of the key benefits that the MWCB mechanism was designed to provide in the first place. Rather than shorten the cooling off period and risk this benefit, the Exchange believes the market would be better served by a change to the length of the associated trading halt that mirrors coordinated market practice. As is the case today, the Exchange would reopen for pre-market trading at 4:00 a.m. ET or later on the following trading day.

– Second, the new Night Session may be subject to different liquidity and participation considerations than the current pre-market session. Notably, while retail investors have expressed interest in overnight trading, the Exchange expects that institutional investors will take more time to transition to a round-the-clock model. However, such institutional participation may be of heightened importance following a Level 3 halt as these investors are likely to have views on the underlying market events that led to the Level 3 Market Decline in the first place. The Exchange is concerned that opening during hours that such participants do not normally trade may impact the quality of price discovery at a time of significant market volatility. Waiting until 4:00 a.m. ET or later to resume trading would facilitate broader participation and therefore price discovery.

– Finally, the Commission recently approved an amendment to the Plan to Address Extraordinary Market Volatility that would establish new price protections from 9:00 p.m. ET to 4:00 a.m. ET. While these price bands would help to assure a fair and orderly market during normal market conditions, it is possible that they would instead prevent normal price discovery following a Level 3 Market Decline. Rather than allowing trading to resume with such price bands in effect, which would represent a change from the current reopening following a Level 3 Market Decline, the Exchange believes that waiting until 4:00 a.m. ET to resume trading would ensure that price discovery can occur during pre-market trading, as it does today, which may further inform prices going into the opening auction and regular market hours trading following a Level 3 halt.

Given those factors, Nasdaq is amending its rule to state that trading in all NMS stocks should not resume until 4:00 a.m. ET or later following a Level 3 halt. Nasdaq expects other SROs to effect amendments that say that trading will resume on or after 4:00 a.m. ET or the applicable morning resumption time depending on the normal reopening time of each SRO. As noted above, this update is in addition to the 20% Limit Up-Limit Down protections that will apply to individual equities. Members can visit our “Trading Window Procedures” Practice Area for additional resources.

– Liz Dunshee