Federal regulators' lack of research into waning market liquidity is getting frustrating, J. Christopher Giancarlo, a commissioner at the Commodity Future Trading Commission, said.
Giancarlo, speaking on an Oct. 12 panel discussion at Georgetown University’s McDonough Business School, made his criticisms just a few days after the most recent “flash crash” in which the British pound dropped 6 percent against the U.S. dollar
“I'm disappointed, quite frankly, with the role of the Financial Stability Oversight Council in not providing a more thorough analysis of trading liquidity in markets,” Giancarlo said.
In the wake of 2008’s financial crisis, regulators placed a premium on increasing the level of capital on banks’ balance sheets by a significant margin. Giancarlo argued that post-recession mindset has contributed, along with the dramatic increase in algorithmic trading, the rise in market price volatility.
“We’re not asking the opposite side of that [balance sheet capital] question, and that is not how much capital to take out of markets, but how much capital needs to stay in markets to provide healthy trading environments and to avoid incidents like we had last Friday with the flash crash and a dozen other flash crashes over the last seven years,” Giancarlo said.
Additionally, Giancarlo said he fears the type of liquidity being provided in markets as more and more dealer capital is being pulled out.
“The dealer is the one who holds inventory for clients and will move in markets to take advantage of price anomalies,” he said.
Non-dealer financial firms are entering markets at an increasing rate and altering the nature of liquidity, Giancarlo said.
“I’m very concerned about the different nature of liquidity provision being provided by proprietary trading firms that have a different objective in markets and, therefore, when you go into times of thinner liquidity, a sudden change by an algorithm can trigger a chain reaction,” he said.
Barriers to entry.
Steve Luparello, director of the Securities and Exchange Commission’s Division of Trading and Markets, joined Giancarlo on stage and asked him how he could be sure that altering the approach of regulators to focus more on market liquidity relative to individual capital requirements would result in return to liquidity provision by dealers.
“I think one of the potential reasons [why they wouldn’t return] may be because of technology and because I think there’s less of a barrier to entry than there used to be,” Luparello said. “At least in the equity markets…before [the] Dodd-Frank [Act], before changes in capital expectations, you just saw the market get more democratized because of technology and it became harder to be as profitable than has been [the case] historically.”...MORE