Who’s to blame for market glitches?
–Tanuja Randery is the CEO of trading services firm MarketPrizm. The opinions expressed are her own.–
A recent spate of high profile trading glitches at NASDAQ, Goldman Sachs and China-based brokerage Everbright, have once again put the spotlight on electronic trading technology and in particular, high frequency trading (HFT), which uses complex algorithms to analyze multiple markets and execute orders based on market conditions.
Since its inception, electronic trading has raised transparency, lowered costs, ensured a better audit trail and dramatically expanded global trading levels. However, as trading gets faster and faster, the pressure to keep up with quickly moving market needs can lead to using technology before the right controls or audits are in place.
Over the last several months, regulators have been proposing measures to rein in HFT. In July, the Business, Innovation and Skills Select Committee of MPs released a statement urging the government to assess the potential impact and feasibility of implementing a financial transaction tax (FTT) on high frequency trading.
There have also been calls in the UK for an HFT tax. But critics have said that both a FTT and HFT tax could drive many high-frequency traders away from Europe and towards alternative markets in Asia, where electronic trading is growing sharply, and the US.
Instead of onerous taxes, markets would benefit more from a requirement for companies to test their systems before they are released. The spectacular failure of Knight Capital last year, which was the result of the company failing to test its software properly, demonstrates the importance of greater testing time of algorithms before introduction to the market. Regulators should also focus on other potentially beneficial measures such as pre-trade risk checks and stress tests in addition to regular audits.
The lack of oversight of exchanges is another issue. For example, vendors are bound by service level agreements (SLAs), which means they are accountable for the reliability of the systems they release into the markets. However, exchanges are not bound by comparable agreements, which means there is less oversight and, as a result, more margin for error.
Finally, exchanges may need to recognise the fact that unwieldy legacy systems can no longer keep pace with today’s demanding trading environment where numerous public exchanges compete in a fast-changing and low-margin business. So a major investment may be needed in systems that are smaller, more modular and more nimble.
Glitches happen but getting the exchange up and running again as quickly as possible with minimal repercussions is of paramount importance—as is ensuring that whatever caused the problem, whether the result of human or technology error, does not happen again.
New chairwoman of the SEC, Mary Jo White, said that she will push ahead with recently proposed rules that would add testing requirements and safeguards for trading software.
It is to be hoped that Ms. White will take a balanced view of electronic trading, taking into account the human error behind the problems we’ve seen recently, rather than laying the blame solely at the feet of new technologies.