The 20-minute "flash crash" will reverberate for quite some time to come. For years, America's stock markets were the envy of the world, the model for modern trading -- fast, stable, efficient and for the most part transparent.
But after the Dow Jones industrial average plunged nearly 700 points on May 6 before sharply rebounding, that perception changed, possibly for good.
"On May 6, I recall this beautiful flash crash that was experienced by many of you," French Finance Minister Christine Lagarde sardonically told those gathered at a World Federation of Exchanges conference in Paris this week. "Well, we certainly don't want that to happen, and neither do we want somebody to press the wrong key and as a result encourage a nice algorithm to precipitate it."
The close examination of market structure in the wake of that stomach-churning freefall surprised even the most grizzled investors. They learned that a lone trader using computerized trading codes can submit tens of thousands of orders in a single second. As a result, many of the technological advances that are the hallmarks of modern stock markets are now viewed with at least a little suspicion.
"In the last 20 years came computers, electronic exchanges, dark pools, flash orders, multiple exchanges, alternative trading venues, sponsored access, OTC derivatives, high-frequency traders, MiFID in Europe, NMS in the U.S.," Thomas Peterffy, founder of Interactive Brokers Group
"And what we've got today is a complete mess."
The flash crash has altered the heated debate over how to reconstruct the European Union's interconnected marketplace. And in Asia and Latin America, the aftermath is threatening to hamstring needed upgrades to trading systems, several industry executives and regulators told Reuters.
In a nutshell, the crash put the world's most sophisticated trading firms, hedge funds and brokers on the defensive, and it strengthened the hands of some traditional investors and even politicians who had agitated for better safeguards in the complicated marketplace.
The fallout has just begun.
Regulators, playing a bigger role, will at the very least shine a brighter spotlight on today's high-speed marketplace. At the most, they could try to put the brakes on trading advances that are now commonplace.
The Dow was down 1,000 points when it touched bottom on May 6. Based on the Wilshire 5000 total market index, the broadest measure of U.S. equities, that represented a brief paper loss of about $1 trillion from the day's open.
The incident muzzled exchange operators who previously rarely missed an opportunity to remind the world that public markets were relatively unscathed as the 2007-2009 financial crisis unfolded in private over-the-counter markets.
"I think we were sort of feeling very confident about that, and the flash crash has to some extent dented that confidence," Jane Diplock, executive committee chairman at the International Organization of Securities Commissions (IOSCO), said in an interview. "While the flash crash, fortunately, did not bring about systemic collapse, what it did was it showed us how important it is to understand what's happening in markets."
Earlier this month, the U.S. Securities and Exchange Commission and the U.S. Commodity Futures Trading Commission issued a report that said a single, computer-executed sale worth $4.1 billion by a money manager helped trigger the flash crash.
The 104-page report concluded that the liquidity crisis that day was exacerbated by high-frequency traders quickly offsetting their positions between futures and stocks, and by the overall crush of sell-at-any-price orders.
Exchanges globally have seized on the role that "market fragmentation" played in dispersing and sapping that liquidity -- that is, the availability of bids and offers. Stocks trade on 50 some venues in the United States, where the market is more fragmented than in Europe.
"There is a balance between market integrity and complexity, and the U.S. market, lately, seems very complex to us," Rainer Riess, managing director of Deutsche Boerse's cash equities section, said in an interview.
At the Paris conference, exchange executives repeatedly urged a crackdown on the alternative trading venues that have proliferated, driving down trading fees and eroding their market share over the last decade.
"This incident on May 6 is a symptom of market fragmentation and a call to better coordinate," said Dominique Cerutti, deputy CEO of NYSE Euronext. "It's a real life, sad example that bad things can happen if you don't take care."
The SEC opened the door to alternative trading venues in 1999, and made them an integral part of the national order routing system with so-called Regulation NMS in 2005 -- two big decisions to spur competition that shaped today's marketplace. The EU took similar steps with its 2007 markets in financial instruments directive, or MiFID, while these low-cost high-tech venues have also cropped up in Canada, Japan and elsewhere.
The European Commission's sweeping review of MiFID, which began before the U.S. crash, has zeroed in on "transparency" in markets.
It could as early as this year propose tighter rules for both the alternative venues that publicly display prices, and for the so-called dark pools that keep prices anonymous -- venues that are typically owned by the world's biggest banks including Credit Suisse Group AG and JPMorgan Chase & Co.
Whatever the flash crash's ultimate impact, it has the potential to revamp the way tens of trillions of dollars circulate through the world's stock markets. It could also spell significant changes to the business models of banks, brokers, exchanges, funds, and the increasingly dominant proprietary trading firms that all interact daily.
The biggest battles in coming years will likely center on so-called high-frequency trading, or HFT, in which firms use computer codes called algorithms to submit rapid-fire bids and offers, making short-term markets and earning tiny profits on price imbalances.
Having effectively replaced the trading floor specialists of years past -- and often based in offices nowhere near Wall Street or the City of London -- these operations remained quite profitable through the volatile market drop two years ago this month. HFT is now involved in an estimated 60 percent of U.S. stock trading, and 40 percent of that in Europe.
The battle lines are now being drawn.
In a July draft report, British EU lawmaker Kay Swinburne called for a full examination of HFT's costs and benefits, as well as "stress tests" to determine how exchanges would handle a European version of the flash crash. Top European Commission member Michel Barnier went a step further on Tuesday, declaring that HFT needs new governing rules given the inherent risks it poses.
"I think a number of us are coming to the view that this high-frequency trading has negative social value, and that it's not information discovery," Nobel Prize winning economist Joseph Stiglitz, a member of the joint CFTC-SEC advisory panel studying the flash crash's implications, said on Sept. 30.
"They're playing games. They're trying to extract information from informed traders, people who are doing the research," Stiglitz added at a reception hosted by Thomson Reuters in New York.
SEC Chairman Mary Schapiro has said HFT strategies need a closer examination, and the agency is considering saddling such traders with market-making obligations and privileges so that they provide liquidity when it is most needed. Such a move would put U.S. markets at sharp odds with Europe, which has done away with market makers.
All this tough talk has spooked high-frequency traders and the exchanges that rely on their liquidity and volumes. They note that HFT was not blamed outright in the SEC-CFTC flash crash report, and argue that its short-term strategies have made trading cheaper and easier for all investors.
Richard Balarkas, CEO of Instinet Europe, the Nomura Holdings Inc-owned <8604.T> agency brokerage and alternative venue operator, said winding back the clock is a mistake.
"I don't think investors on the whole want to go back to a market where they all pay a tax, usually in the form of a wider spread, to a firm making monopoly profits that will in any case wave a white flag as soon as a stock has a liquidity shock," he said in an interview.
"It's crystal clear why the flash crash happened: a lack of buyers, and unthinking selling. It was pure, simple supply and demand within a regulatory regime that the SEC had created."
The soul searching in the United States and Europe has spawned some anxiety elsewhere. Exchanges in Asia and Latin America invested heavily in recent years to install electronic matching engines and order routing systems to attract the very kind of trading now under the microscope.
Executives said that while there are lessons to be learned from the flash crash, there is a danger in overreacting.
"It's unfortunate for places like India, that the confidence among the global regulators was shaken in exchanges in the developed countries," James Shapiro, head of market development at Bombay Stock Exchange, said on the sidelines of the Paris conference. "India is basically now where it needs more deregulation to some degree. This has introduced an element of caution."
Atsushi Saito, CEO of the Tokyo Stock Exchange, which launched a $140-million super-fast "Arrowhead" stock trading system in January, told the conference: "We are carefully watching the report from the United States on this May 6 event... But we are very uncomfortable about the demonization of high-frequency trading."
When so-called MiFID II takes effect in 2012, it could set the tone for any possible cross-border marketplace in East Asia, where, as in Australia and Brazil, exchanges face the prospect of new competition and a race to ever-faster electronic trading in the near future.
It is here that the most severe aftershocks of the U.S. flash crash could hit, said Joseph Gawronski, president at New York-based institutional broker Rosenblatt Securities.
"Certainly the incumbents don't want to see fragmentation," he said. "But at the same time they do want to see high-frequency trading come to increase their velocity. And that's a very fine line."
(Reporting by Jonathan Spicer; editing by Jim Impoco and Claudia Parsons)