Slap on the wrist for the algorithm trading industry

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Regulators in the UK (FCA) have warned that guidelines and rules for the fast growing algorithm trading industry are not being followed appropriately by some suppliers. Very often, algorithm trading is poorly designed and not monitored, leaving traders and financial markets wide open to disruptive trading, mistakes and market abuse. Algorithm trading often happens at rapid speeds which can amplify the risks even further. The consultation between the Financial Conduct Authority and the Bank of England was put in place after commentators queried the role of algorithm trades in situations of market turmoil and upheaval.

FCA Comments on Algorithm Trading

The regulators commented that in some instances rules on algorithm trading were not being followed and that “well defined and understood deployment procedures are critical to reduce the errors in algorithmic trading”. The 2012 example of the loss of £440m in 30 minutes by the Knight Capital Group was highlighted as an example of the type of trading to be avoided. The loss was caused by an error in the Knight capital Group’s trading system and caused a knock on effect for the stocks of about 150 companies.

Regulators have warned that algorithmic trading companies should consider the potential effects of algorithmic trading upon market integrity and monitor for issues while reducing risks of market abuse. Firms are also advised to utilise robust testing and development processes to ensure potential issues are identified prior to the launch of any algorithmic trading platforms.

The regulators highlighted examples of senior staff at algorithmic trading firms having little or no understanding of how the algorithms work and being unable to identify any risks to the trading model or the wider markets.

The report highlighted a number of issues within the rapidly growing algorithmic trading industry and identified that companies sometimes failed to maintain adequate records of incidents and breaches of the risk parameters. Other companies failed to correctly monitor issues of market abuse. The regulators highlighted that market abuse alerts on issues such as insider trading or layering are being maintained, however, issues such as momentum ignition and reference price gaming also needed to be considered.