The Investment Industry Regulatory Organization of Canada has reviewed the circumstances surrounding the Canadian version of the “flash crash” on May 6, and recommends a handful of changes for regulators, dealers and markets.

IIROC’s review finds that the Canadian marketplaces reacted rapidly to the U.S. decline, but that there is no evidence of erroneous orders, computer glitches, or any futures or options trading that spurred the decline.

Instead, it found a number of factors that contributed to the extreme trading that day, including: the existence of large sell imbalances; the behaviour of major electronic traders, such as high frequency traders and electronic liquidity providers, which quickly withdrew from the Canadian market when the U.S. decline occurred, drying up available liquidity; the absence of traditional market makers in some of the affected securities; the triggering of stop loss orders, which the IIROC found was “a major contributor” to the deep price declines experienced by certain securities; and, differences in volatility controls between marketplaces.

The review concludes that “aberrant or volatile trading in one jurisdiction can easily and very quickly spread to other jurisdictions”; and, therefore, it recommends that the Canadian Securities Administrators and IIROC should review the current market-wide circuit breaker to determine if the current trigger levels are appropriate and whether an independent Canadian-based circuit breaker level should be considered. It also recommends that regulators consider the adoption of single-stock circuit breakers, as the U.S. Securities and Exchange Commission has done in the U.S. in response to the event.

Additionally, it recommends that all Canadian marketplaces adopt volatility controls, and that these controls should be reviewed to assess to what degree they ought to be harmonized among markets.

The review also calls on dealers to consider how to effectively manage the use of stop loss orders in the current high-speed, multi-market environment. It says that IIROC firms should provide all their reps and clients with guidance on the use of these orders.

Finally, it concludes that IIROC should review its policies for handling erroneous and unreasonably priced trades.

The report says that regulators are already considering the introduction of single-stock circuit breakers and that IIROC will soon be issuing a request for comments on a proposal. The CSA and IIROC are also currently examining volatility controls in the context of an electronic trading rule and will recommend a course of action. IIROC will issue guidance to dealers and investors on the use of certain order types, and it is planning an educational seminar for investors to help them understand the challenges of trading in the current market environment. And, the proposed review of erroneous trade policies is also underway and will be published for comment when completed.

The proposed review of the existing market wide circuit breaker is the only project yet to be started, and that’s because U.S. regulators are still reviewing these mechanisms too. “As the North American financial markets are very interconnected and the current market wide circuit breakers are based on those in the U.S. which, in turn, are under review, IIROC will work with the CSA and will consult with both Canadian marketplace participants and U.S. regulators on this issue,” it says.

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