Market outages have hit the headlines repeatedly in recent years – and while acts of God might be inevitable, there are still some actions the industry can take to mitigate their disruption. From better communication and enhanced planning and assessment to the introduction of a consolidated tape, Alex Pugh looks at what happens to the market when liquidity providers are locked out – and how we can work to avoid another impact.

FIA European Principal Traders Association (EPTA) looked at a market outage in May 2023 and used the event to gather data on the wider market effects of such an outage, particularly around the absence of market makers. What did that event reveal, what can earlier events teach us, and how can the industry work together to improve?

Prologue

In November 2022, Nasdaq saw a closing price failure across four of its Scandinavian exchanges. In October 2020, Euronext experienced an outage that saw a large chunk of the EU equity market frozen for several hours. In the same month, Tokyo Stock Exchange chief Miyahara Koichiro resigned following a hardware malfunction that caused a day-long blackout.

In June 2023, SIX Swiss Exchange suffered an outage which involved the cancellation of both equity and fixed income trading for three hours – its most serious outage in a decade. Sources suggested the issue was caused by an unmatched order.

In October 2023, a market outage at London Stock Exchange left some securities suspended from trading, along with AIM. In December that year, the LSE saw small-cap trading halt twice within a three-hour period, leaving only the FTSE 100, FTSE 250 and IOB securities remaining available for trading. And in March 2024, Nasdaq faced a system outage that left it paralysed for almost three hours.

The Event

Few leading exchanges have avoided the issue of a market outage. The event analysed by FIA EPTA, however, referred to the morning of 3 May 2023 – when pan-European stock exchange Euronext experienced a technical configuration issue.

The glitch prevented registered liquidity providers (LPs) from sending orders to the venue and, for just over three hours, provided a ‘real world’ experiment on how markets manage both with and without active LPs – and by consequence, the value that these provide.

The Effect

LPs’ inability to access the exchange led to materially decreased volumes and increased the cost trading. While simulating such an event would have been impossible, the live example revealed the “fundamental importance” of liquidity providers in European secondary markets, according the FIA paper.

FIA EPTA used historic market data from that day to compare metrics across the impacted and unimpacted stocks on the market in question and on Europe’s largest Multilateral Trading Facility (MTF), Cboe.

The impact on liquidity was stark. The spread at the BBO of the exchange’s order book was on average 1.059 bps (almost 14%) wider than the 30-day moving average, representing a material increase in the cost of trading on this exchange.

Volumes decreased significantly, with the available liquidity at the Best Bid and Offer (BBO) shrinking to less than two-thirds of the historical norm on the exchange.

“In practical terms, an investor executing a €5,000 (£4,267/US$5451) order, a typical average trade size, paid a spread 1.68 bps wider than the 30-day average (a 20% increase). For a €10,000 order, the spread was over 3 bps wider (a 35% increase), representing a significantly higher cost of trading for investors,” the FIA EPTA report noted.

The Feedback

Cboe and Aquis published a paper in 2021 which outlined a three-pronged proposal to address market outages. The paper recommended that all trading venues should adhere to a set of minimum standards for the handling and communication of such outages; make it easier for market participants to trade elsewhere; and take steps to ensure an orderly re-commencement of trading on its venue following an outage.

The paper also highlighted where regulatory guidance or action could support improvements in the resilience of Europe’s equity markets to technical outages, including the establishment of a real-time pre- and post-trade European Consolidated Tape; regular assessment of the effectiveness of outage protocols developed by venues; obliging venues to publish annual documentation on their infrastructure resilience model; and curtailing reliance on the Most Relevant Market (MRM) concept.

The paper said that while market outages are “largely inevitable”, they are highly disruptive, particularly when experienced by national stock exchanges, or ‘listing venues’ (LVs). Outages during official opening and closing auctions are especially problematic due to the lack of alternative/competing mechanisms, and to the importance of auction prices to fund and ETF benchmarking. This situation weakens the overall resilience of the European market as listing venues remain single points of failure, vulnerable to accidental technical outages and other threats such as cyber-attacks.

FIA outlined to Global Trading its “main asks” from venues regarding the prevention of and way of dealing with outages. These include clear, meaningful and frequent communication; conclusive statement on order status prior to re-opening; prioritisation of a venue’s ability to operate the closing auction and print a closing price; a consistent pre-determined methodology for an alternative closing price; efficient and robust trading venue governance structures for the management of outages; and post-mortems should be made public to all market participants.

The Tape

Natan Tiefenbrun, president, North American and European equities, Cboe, told Global Trading that while outages are unavoidable, the industry could be better at improving the communication around such events and limiting their impact.

“We believe a real-time pre- and post-trade consolidated tape will significantly help, so that in the event of an outage – particularly on a primary exchange – investors and brokers will be able to use the tape to continue trading across other pan-European venues, such as Cboe.”

More broadly, in addition to having access to alternative venues, brokers and other market participants need to identify and address single-venue market data dependencies in trading and ancillary systems, Tiefenbrun told Global Trading.

Tiefenbrun said the industry should also agree to a well-defined and consistent approach to calculating an official closing price in the event of a primary outage which prevents the closing auction from running.

“This must be an addressable liquidity event in which the buy side can participate, rather than a stale pre-outage price. Rather than introduce new or unproven alternative market mechanisms, we would support a form of volume weighted average price during the last 15-30 minutes of continuous trading across all remaining venues. Again, a consolidated tape could assist with disseminating this VWAP so that asset managers and benchmark/index publishers can consume it,” he added.

The Rub

LPs contribute to tighter spreads, and therefore lower costs of trading, and provide a significant proportion of the resting liquidity with which an incoming order can interact during continuous trading hours on public lit markets. Without the anchor liquidity provided by LPs, spreads are wider, and liquidity decreases by a substantial amount, especially for investors looking to execute above-average-sized orders.

The absence of LP liquidity also resulted in a drop in the market share for the exchange as market participants sought to trade on other venues where LP liquidity was still available.

“These observations also highlight how normally robust liquidity in European equity markets is materially diminished when liquidity providers are not present, highlighting the need for Europe to ensure its regulatory framework is appropriately tailored to support liquidity, encourage competition and retain the interest and participation of a broad spectrum of different investor and firms types, including the LPs who provide this liquidity,” the FIA EPTA report noted.

Market maker Optiver has suggested market participants create an alternative pan-European closing mechanism. According to Rosenblatt Securities, end-of-day auctions attract around 15% of total European equity volumes — spiking to 25% on major option-expiry and index-rebalance days – making even the possibility of an outage a serious concern.

ESMA recently published an opinion on how venues should handle a market outage, including a clear outage plan and a possible “order book purge” for compromised participants. However, Optiver called on listing venues to “set aside commercial considerations” to act in the best interests of the market via an alternative pan-European closing mechanism.

The market maker also thinks a back-up auction would deliver better outcomes than the long-proposed pan-European consolidated tape.

Optiver wants to see industry-wide cooperation, both between listings exchanges themselves as well as derivatives-market operators, mutual fund and ETF issuers, which would need to recognise the prices set by an alternative closing facility as a benchmark for their products. Optiver also wants regulators to “speed this along” by mandating stock markets to designate responsibility for closing auctions under outage conditions.

The Future

Sam Railton, director, business development, EMEA, Tower Research Capital, told Global Trading that market outages highlight the fragmentation of European markets and the dependence on primary markets for price discovery. Nonetheless, creating a raft of new rules, mandates and guidance – for events that are inevitable but often brief and infrequent – is unnecessary, Railton said. “It is a problem for everyone all at the same time, and it rarely lasts longer than a few hours.”

“The effort should really focus on standardisation of communication. Outages should be clearer to understand – when they started, who they affect, and the best estimates when they are likely to be resolved.”

“The fact is that the MTFs don’t have quite as broad a mix of diverse participants as the primaries, they don’t have quite so many locals in each of the jurisdictions. And for that reason, it changes the flow dynamic and so people are a lot more nervous about just moving the flow, particularly given that they think that the primary might come back at any minute,” Railton added.

Giving people a rough window of time during which the outage will last will ameliorate some of this, Railton said.

“In an ideal world an exchange would be completely honest and say we are experiencing this massive outage, realistically we are not going to be back for four hours. People might start moving volume to somewhere else. The problem is, it is not in the exchange’s interest to say that; it is in their interest to say we are going to be back as soon as we can and hopefully within an hour – and then everyone just keeps waiting,” Railton said.

As well as standardising communications, Railton also highlighted the usefulness of a consolidated tape during a market outage. “If that existed, people might have a bit more confidence that there is volume going off elsewhere. But that can only help this problem, I do not think it solves it. And I do not think anything else that we do is going to be worth the effort to solve it either.”