Outage halts trading on London exchange

LONDON - Share prices rose and international markets rallied in reaction to the US government's rescue of stricken mortgage lenders Fannie Mae and Freddie Mac, but at the London Stock Exchange (LSE) screens froze and traders were left in the dark.

Orders were suspended at around 9.15am, just as market activity began to surge in the wake of the Fannie and Freddie bailout, and trading did not resume until 4pm. The LSE blamed the outage on a combination of technical events occurring simultaneously, which affected the stability of connections between some exchange member firms and the trading gateways. The LSE says it immediately implemented software enhancements designed to prevent a recurrence of the problem. Normal trading resumed the following day.

During the outage, traders were looking to the newly established multi-lateral trading facilities (MTFs) such as Turquoise or Chi-X for some respite, but the MTFs failed to capitalise on the outage as they and most broker-dealers still rely on the prime London exchange to set reference prices.

Chi-X spreads at best bid and offer for the 30 largest FTSE100 stocks on Monday demonstrate how they were affected by the lack of reference prices from the LSE, as prices moved right out when it was offline and back in again once trading resumed. The LSE suggests the spreads show there was not sufficient liquidity for effective price formation, but it also demonstrates the reluctance or lack of confidence of traders in trading on MTFs without the surety of a reference price from the prime exchange. Equally during the most recent market turmoil following Lehman Brothers filing for bankruptcy protection, the LSE has seen an increase in market share for trading banking stocks, which suggests that during such uncertainty the market is favouring trading on the prime exchange and strongest pricing mechanism. A further advantage the LSE has over its rivals is its default rules. Since Lehman's collapse, the LSE has been negotiating the final positions, or hammer prices, of the investment bank's stock; most other trading venues do not offer this service, leaving their traders working this out themselves.

"The LSE is generally used for reference prices, and when it went down, although trading could still be carried out on the MTFs without the primary market, many were afraid to do so," says Jitz Desai, director at London think-tank JWG-IT. "Traders were worried as there was a whole portion of the market they didn't have a price for. If the volumes and market shares were more evenly balanced across the venues, trading could have continued normally on the other venues."

PJ Di Giammarino, chief executive officer at JWG-IT, says: "This event highlights two interesting points. One is that we are still in a transitional environment - if this had happened a year from now we would expect a reaction in the trading algorithms, and the traders themselves to be more comfortable with the other prices and not be so dependent on a primary market. But with these new MTFs only just coming online, everyone is still a bit wary. If that is the case, the second point that has to be made is, 'how are the investment firms pulling together their reference pricing and indexes?' If they are that reliant on the LSE price, do they really understand what is happening across the 260 other execution venues in the market? A number of people have raised questions about this, but it is a very complex arena, and the market is so fragmented that it begs the question about whether traders are considering all the right venues."

With trading volumes set to accelerate further as even more European execution venues emerge, financial institutions are under pressure to address a data latency problem and update their infrastructure rather than worry about identifying new venues and connecting to them.