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Safeguard mechanisms ensured orderly trading post ECB rate announcement

Release date: 17 Feb 2014 | Eurex Exchange, Eurex Group

Safeguard mechanisms ensured orderly trading post ECB rate announcement

Eurex – Providing background information on the DAX® Futures (FDAX) behavior around the ECB announcement on 6 February

On 6 February 2014 at 13:45 CET the ECB made its regular monthly announcement on interest rates. The publication of the rate decision followed the standard ECB protocol and was in line with market expectations.

Given that ECB decisions always have the potential to move markets, trading and orders tend to be significantly thinner than normal just before and following the time of the announcement, as market participants either remove or reduce their orders in expectation of potential market moving information.

On 6 February, just 4 seconds and 403 milliseconds after the ECB’s rate news – strong selling pressure emerged in the FDAX. In the following 414 milliseconds this pressure started to push prices sharply lower as 49 sellers and 82 buyers traded 1,488 contracts.

This kind of situation is often, as was the case on this occasion, triggered by one party placing a large or series of sell orders which are unreasonably large relative to the liquidity available in the order book at the time. While this kind of situation is rare, it can potentially happen at any time. Accordingly, Eurex has built in a number of safeguard mechanisms to manage the impact of just such an event. In addition, there is always after any such event, an ex-post analysis of the behavior and motives of the market participants behind the selling pressure.

Figure 1 shows the FDAX price movement in the relevant time period during which the large selling pressure hit the market. It is separated into three phases:

• Sharp price decline phase (414 milliseconds)
• Volatility interruption phase
• Re-opening of trade phase
Figure 1 (updated, 19 Feb 2014): development of FDAX prices and volume

Sharp price decline phase (414 milliseconds)
As can be seen in figure 1, despite the selling pressure which caused the FDAX to fall by 2%, the market did not drop like a stone, but traded in an orderly way. There were plenty of up-ticks (upward price movements) during that time, as well as a substantial rise in liquidity as reflected in the high number of traded contracts (1,488 in 414 milliseconds compared with an average of less than 5 contracts per second).

The individual price moves were small and regular. A total of 254 sell orders were executed. Throughout Eurex safeguard mechanisms kept the market in check. Two particular safeguards were particularly relevant in this crucial period: the Volatility Interruption (described below) and the Market Order Matching Range Concept. The purpose of the latter can be described as follows:

Swift downward moves generally trigger – as in the case of the Feb 6 ECB announcement – Stop Loss Orders. Triggering Stop Loss Orders in this situation means the generation of Sell Market Orders, which push the market down further. This can lead to a vicious circle, often also referred to as a cascading stop loss orders cycle. The Eurex system prevents this by validating the market order against an actual reference price (Market Order Matching Range Concept). The result is, that sell market orders will only be executed within a given range (market order matching range), preventing a possible cascading stop loss order cycle and mitigating the risk that prices plunge in a disorderly way. As the market moved down during this period in an orderly manner, a significant number of Stop Loss Orders got filled as the liquidity on the bidding (buying)-side rose to the challenge.

Volatility Interruption Phase
The risk that markets decline in large price drops is not only a result of market orders but also limit orders. To guard against that, in its benchmark products, the Eurex system validates every single trade against price bands within given time frames. If the system concludes that price determination lies outside the price bands, it automatically stops regular order book trading. The process is called a Volatility Interruption. In the case of the ECB announcement, the Eurex system concluded 414 milliseconds after the emergence of the selling pressure (4 seconds 817 milliseconds after the ECB announcement), that the given price bands had been exceeded. As a result, the Volatility Interruption mechanism was duly triggered.

A Volatility Interruption does not mean that Eurex halts trading in the affected instrument, rather it marks a change in the market model from continuous trading in an open order book to that of an auction. During the auction phase, Eurex market participants can enter, delete and modify orders. That said, these orders will not be automatically matched but rather pooled until the end of the auction phase. Throughout the auction, Eurex supports market participants by creating transparency via a display of the indicative auction price. This is the price at which the auction would conclude, if it were stopped at that time. The Volatility Interruption has a number of aims:

• Preventing large price moves in either direction as a result of erroneous order entries, an illiquid market situation or, as in the case of the ECB announcement, cascading stop loss orders.
• Participants also get the opportunity to review the situation: Look at the overall picture, take other markets into consideration and review their own order management situation.
• Providing experts at Eurex Market Supervision with the time to review the situation e.g. order book situation, news situation and the causes of the incident.
• At times of market frenzy – which was clearly not the case on February 6 – it provides a cooling-off period for all market participants.
• Bundling market liquidity: A price built from the bundling of orders of hundreds of participants is much more robust and useful than a single price resulting from the interaction of just two orders in a fast-moving order book.

The auction, and therefore the Volatility Interruption, is manually steered by the experts at Eurex Market Supervision. They review the overall situation and the auction process. The market will re-open with an auction price and the switch back to the continuous trading mode, once these experts conclude that the auction order pool will produce a robust new price level. In the case of the ECB announcement it took 3 minutes and 51 seconds. The auction ended with a transaction of 640 contracts at a price level of 9,173, 1.8 percent above the last price recorded before continuous trading was replaced by the auction mode.

Re-opening phase
As can be seen in figure 1, the market returned to normal trading around the price level established by the auction. Please note, that in more extreme market situations with significant new information, the market could also continue to decline after an auction, as it might still need more time to digest market news. This was clearly not the case on February 6.

In summary, during a very short time period, immediately following the ECB announcement, Eurex experienced significant selling pressure in the FDAX which pushed prices down in an orderly manner, triggering a large number of stop loss orders, which prompted further selling pressure. Eurex trading safeguards worked in the way they were designed to, guaranteeing orderly price determination and the integrity of the market at all times.