News

Regulators Urged to Wake Up and Smell the Coffee Over Trading Glitches

08.28.2012

Another week, another trading glitch it seems.

The latest in a string of high-profile trading debacles saw exchanges, most notably the Nasdaq stock exchange in New York, forced to cancel trades last week after an erroneous order brought about a steep and sudden rise in the share price of Peet’s Coffee and Tea.

This follows on from a faulty algorithm that nearly bankrupted U.S. market maker Knight Capital earlier this month, while in May trading glitches marred Facebook’s initial public offering on Nasdaq.

Some in the market are blaming the rise of automated and high-frequency trading, which, they say, increases the likelihood of mistaken orders occurring. In each case, HFT has been left unchecked and has caused severe problems.

“First the Facebook debacle, then Knight Capital and now Peet’s Coffee and Tea,” said Rik Turner, senior analyst, financial services technology at U.K. consultancy Ovum.

“The world of automated trading, to which the high-frequency variant has added piquancy, is back in the spotlight this week as yet another technical error causes short-term distortions in a market already fretting about on going global economic woes generally and eurozone sovereign debt in particular.

“This latest glitch can only increase the volume of calls to ban, or at least seriously restrict, the activities of the HFT community.”

Turner adds that rather than imposing constraints on HFT, regulators “would do better to encourage the adoption of faster and better monitoring technology at the trading venues”.

Regulators across the world, though, are at different stages of evolution with regard to HFT.

In Hong Kong, its Securities and Futures Commission last month issued a proposal that would require all trading algorithms to be tested and audited once a year. While in Australia, its Securities and Investments Commission this month proposed a rule that will require brokers to gain direct control over all algorithmic-based trades.

Europe, too, is looking to crack down on HFT. Germany plans to curb HFT through legislation while France is opting to use a financial transaction tax as a means of reducing HFT in its markets. The European Union, through its as-yet-agreed-upon MiFID II proposals, is also looking at cracking down on the practice. The U.S., it seems, is further behind in the process and is just about at the talking stage.

Some market participants, though, believe that better risk management is key to avoiding these recent market disruptions.

“Our member firms share the concern expressed by many observers and market participants about the problems affecting Knight Capital and the disruptions these problems caused in the U.S. equity markets,” said the FIA European Principal Traders Association (FIA EPTA), which represents firms that trade their own capital on exchange-traded markets such as Knight Capital, Optiver, Getco, Citadel Securities and Quantlab Financial, in a statement on its website.

“Rapid advances in trading technology have brought very substantial benefits for those who use and rely on markets, but there is no question that they also have introduced new sources of risk.

“Technology is a core component of modern markets, and we strongly believe that managing technological change must be an essential element of risk management for all market participants.”

FIA EPTA, in conjunction with its U.S.-based affiliate the FIA Principal Traders Group, believes that trading firms should consider a number of specific tests and controls whenever they change their technology systems to prevent future trading glitches, while the lobby group says that it is working with regulators and legislators in the European Union and the U.S. to implement meaningful and effective reforms.

“It is not clear yet what caused the problems at Knight Capital, but, once the facts are out, we will review our recommendations and amend if needed,” said FIA EPTA. “Knight’s difficulties highlight how quickly the market punishes trading mistakes, but also how important it is for market participants to work with regulators to minimize threats to market stability. We stand ready to share our expertise with regulators as they examine what happened at Knight Capital and consider what reforms are necessary to safeguard our markets.”