Views on improving the integrity of global capital markets
02 April 2012

Three Lessons from the Failed BATS IPO

Posted In: Market Structure

On 23 March, BATS Global Markets — the third-largest operator with a market share of 11 percent of consolidated volume across its two exchange platforms — pulled the plug on its IPO. A quick recap of events: moments into the stock’s debut, a computer malfunction causes a mini “flash crash” in BATS’ stock, preventing it from trading on its own platform, while at the same time a nationwide circuit breaker in Apple Inc. is triggered following a 9 percent drop in that stock’s price on BATS’ system. In the past week, BATS chief executive, Joe Ratterman, lost his chairmanship of the company over the IPO debacle.

What do these events mean? We can draw three conclusions. 

First, let’s look at the mini “flash crash”. BATS reported its opening transaction at $15.25, but only moments later the stock plummeted to just 0.02 cents, causing the IPO to be pulled. All trades in BATS, in which over one million shares changed hands, were cancelled.

Technological glitches such as this are not new, but they are becoming increasingly common. Today, the equity market is very fragmented, extremely fast, and critically dependent on technological sophistication — in essence, it represents a vast, decentralised electronic network, driven by messages sent by one machine to another. While for the most part, these developments have improved the market’s operational efficiency — cutting down processing times and reducing frictional trading costs — the reliance on automation, coupled with liquidity fragmentation, can make for a more fragile ecosystem. The numbers back this up. According to a recent academic paper, extreme price movements or mini “flash crashes” — defined as instances, in a 1500-millisecond time window, where a stock ticks down (or up) at least 10 times before ticking back and the price change exceeds 0.8 percent — numbered 18,520 between 2006 and 2011. That’s more than one such occurrence per trading day.

Lesson #1: The market’s complexity is breeding vulnerability.

Second, let’s look at the 9 percent drop in Apple, triggering a nationwide five-minute trading halt in the stock. There are two parts to this piece of the story, one bad, and one not so bad. The “bad” part is that, according to Bloomberg, the 9 percent share price fall was triggered by a single 100-share order on the BATS system. That’s a relatively small order, even by current standards, which again highlights system fragility. The “not so bad” part is that, although this triggered a trading halt, it at least shows that measures to develop system-wide circuit breakers in the aftermath of the May 2010 flash crash seem to be working.  Consequently, the type of investor confusion that ensued on that infamous occasion — where some stocks were halted on some venues but not on others — was at least avoided this time.

Lesson #2: Circuit-breakers are effective and needed.

As for the third lesson? Put simply, regulators need to pay more attention to the market structure. It sounds like stating the obvious, but it seems that with episodes like these on the rise, it is a lesson that could be better heeded. Although, thankfully, BATS acted quickly to minimize the fallout this time — the lack of market panic is testament to its handling of the situation — there is no room for complacency. On another day, things could be quite different ….

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About the Author(s)
Rhodri Preece, CFA

Rhodri Preece, CFA, is Senior Head of Industry Research for CFA Institute. He is responsible for building and maintaining the global research function at CFA Institute, including leading the planning, coordination, and creation of research content across CFA Institute research platforms, which include the Future of Finance, the CFA Institute Research Foundation, the Financial Analysts Journal, and the Enterprising Investor blog. Preece formerly served as head of capital markets policy EMEA at CFA Institute, where he was responsible for leading capital markets policy activities in the Europe, Middle East, and Africa region. Preece is a former member (2014-2018) of the Group of Economic Advisers of the European Securities and Markets Authority (ESMA) Committee on Economic and Markets Analysis. Prior to joining CFA Institute, Preece was a manager at PricewaterhouseCoopers LLP where he specialized in investment funds.

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