In recent weeks, global markets have experienced a dramatic increase in volatility in reaction to the coronavirus (COVID-19) pandemic. In the United States, market declines have triggered market-wide circuit breakers on multiple occasions, and questions have been raised about potential temporary closures in U.S. securities and futures markets and remedies available in the event that securities transactions fail to settle. Below is a summary of key authorities and procedures. More detail is included in the Annex.
Securities and Exchange Commission (SEC) Chairman Jay Clayton and New York Stock Exchange (NYSE) President Stacey Cunningham expressed strong support on March 16 for keeping U.S. equities exchanges open during the crisis. Meanwhile, on March 17, U.S. Treasury Secretary Steven Mnuchin indicated that President Trump's administration "absolutely believe[s] in keeping the markets open," but also that the trading day may be temporarily shortened.
The President and regulators have the authority, however, to impose greater restrictions on the markets, including halting trading for extended periods, such as after the attacks of September 11, 2001 and in the wake of Hurricane Sandy, or taking steps to alter other aspects of the market, such as the prohibition on short sales during the financial crisis in 2008. These emergency powers include:
- President. The President has broad emergency powers, especially as regards foreign exchange transactions and other cross-border transfers.
- SEC. The SEC can summarily suspend trading of non-exempt securities "on any national securities exchange or otherwise" for a period not to exceed 90 days. This power may be exercised only after the SEC has notified the President of its decision and the President has further notified the SEC that the President does not disapprove of the decision. The President may terminate the SEC's action at any time. The SEC may exercise this power if "in its opinion the public interest and the protection of investors so require." It is expected to consult with the Federal Reserve, the Secretary of the Treasury and the Commodity Futures Trading Commission (CFTC) unless it is impracticable under the circumstances.
- CFTC. If it "has reason to believe that an emergency exists," the CFTC can direct a futures exchange to "take such action as in the [CFTC]'s judgment is necessary to maintain or restore orderly trading in or liquidation of any futures contract, including, but not limited to, the setting of temporary emergency margin levels on any futures contract, and the fixing of limits that may apply to a market position acquired in good faith prior to the effective date of the [CFTC]'s action." An "emergency" includes, among other things, any "major market disturbance which prevents the market from accurately reflecting the forces of supply and demand" for a commodity.
- Exchanges and FINRA. The U.S. securities and futures exchanges and Financial Industry Regulatory Authority (FINRA) generally have broad authority to close their markets. For example, the CEO of the NYSE may halt or suspend trading in some or all securities on the exchange if she determines "such action to be necessary or appropriate for the maintenance of a fair and orderly market, or the protection of investors or otherwise in the public interest, due to extraordinary circumstances" including a "request by a government agency or official."
Although it seems unlikely at this point that these powers will be invoked, market participants should consider potential implications, such as:
- Inability to close out short sale positions or effect buy-in purchases for fails.
- Impact on outstanding derivatives transactions that provide for physical settlement.
- Disruption of the valuation of outstanding derivatives transactions that reference market pricing.
- Inability to hedge outstanding securities and derivatives positions.
The SEC, CFTC, FINRA and securities and futures exchanges have several pre-existing measures in place to address extraordinary market volatility and ensure settlement of securities transactions. These include:
- Market-Wide Circuit Breakers. These measures, triggered in response to price declines based on the S&P 500 Index, halt trading for 15 minutes or, if the market decline is more extreme, can halt trading for the remainder of the day. These circuit breakers have been triggered four times since the outbreak of the COVID-19 pandemic, most recently on March 18.
- Limits Down Procedures. Individual stocks and futures contracts are generally subject to procedures that limit trading outside of a specified price band relative to the previous day's price, with temporary trading halts (e.g., for five minutes in the case of U.S. listed securities) possible if trading does not resume within the price band after a specified monitoring period.
- Short Sale Price Test. Once the price of a security declines 10 percent or more from the previous day's closing price, SEC rules generally prevent the entry of short sales in that security at a price lower than the current best bid.
- Failed Trades. FINRA and other self-regulatory organizations (SROs) have rules that prescribe certain "buy-in" procedures for failed securities trades, and market practices prescribe fails charges for failed trades in government securities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.