03.26.2012
By Terry Flanagan

Buy Side Takes Bats Grounding In Stride

Market confidence was shaken last week when Bats was forced to pull its initial public offering due to a serious technical failure. For the buy side, the fallout could have been much worse.

At the start of trading on March 23, Bats, an acronym of Better Alternative Trading System, experienced a serious technical failure at its first attempt to open its own exchange symbol at the start of trading on Friday morning. Trading was immediately halted, and its long awaited IPO was dead in the water. The company’s chief executive, Joe Ratterman, has yet to announce formalized plans on whether Bats will reschedule an IPO.

While the end-users that held a stake in the Bats deal might feel a bit cheated from a valuation standpoint, institutional buy-side traders feel that the technical glitches are a part of today’s capital markets.

“I don’t have an impression that the markets have systemic problems, and that there are frequent technical glitches,” said Steve Hedger, managing director of trading and investment operations at Fifth Third Asset Management. “I think traders and market participants have an expectation that market glitches will continue to occur, but we all hope that they are rare. My wish is that every market glitch is scrutinized and any technical programming processes are corrected so we don’t have the same identical issues resurface.”

For Hedger, an acknowledgment and, to a degree, an expectation that software bugs are a part of trading in today’s computer-centric world is something instilled in all “tenured traders”. Such an acknowledgment, though, may not prepare market participants for future errors. With events such as the ‘Flash Crash’ in May 2010 in the not-too-distant past, market participants need to be prepared for potentially more technological failures as trading becomes ever-more electronic.

“Tenured traders have watched the markets transform over the decades from very manual workflows to very intense computer intensive processes,” he continued, citing that the key is to focus on market developments that have been created to contain trading glitches. “In Friday’s glitch [when shares in Apple slumped nearly 10% before recovering], Bats showed that the market controls were able to act prudently to protect investors. It appears that putting in the 10% trading halt rule after the 2010 Flash Crash worked pretty well on Friday.”

Still, Bats’ catastrophic failure on what should have been a shining day for trading doesn’t come without punishments. The firm’s founder, Dave Cummings, told The Wall Street Journal that bonuses should be suspended at Bats, noting that “mistakes cost money”.

“I want to apologize for not measuring up to the level of excellence that you have come to expect from us,” Ratterman wrote to customers in a letter, briefly breaking the silence of the company’s long quiet period since it filed to go public last May.

“Technology implementations are prone to failures and unexpected outcomes, even after going through rigorous testing,” Ratterman continued in the letter. “Every market center and every trading participant has experienced technical issues in their history. On Friday we were under the brightest spotlight imaginable—opening our own stock on our own exchange for the first time ever. It doesn’t get much more public than that.”

Bats, whose following largely originates from high-frequency traders, had hoped that claiming its own listing Friday would have steered the exchange toward becoming as competitive as the New York Stock Exchange and Nasdaq, which currently hold 23% and 21% of U.S. trading volume market share respectively. Bats’ market share, which hovered around 11% last week, quickly dipped to 9% on the morning of March 26, according to Bats Global Markets.

Bats’ halt on trading during Friday’s failed IPO will undoubtedly stir concern from regulators, who are already committed to reforming market structure.

Hedger of Fifth Third cited the post Flash Crash regulatory by-product “ten percent drop control rule”, which automatically halts trading after a 10% dip for further inspection, was effective and shouldn’t be overlooked by regulators as a key element towards progress.

For Hedger, market errors are a natural part of capital markets and are designed to help improve the system for the future. He hopes that Friday’s failure will solicit further scrutiny from regulators, which, he says, is “a good thing”.

“I hope some of the transparency that was brought to the market since the Flash Crash will help assist them in their evaluation,” he added. “It should be a confirmation that the regulators’ work over the last couple of years has yielded positive results. If the regulators find that they are still struggling to get their arms around the market structure, it should tell them they need to consider alternative oversight.”

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