The SEC report into the failure of Knight Trading offers an interesting insight into the risks that
are being run across many or, perhaps, nearly all Wall Street equity trading firms. The report
available at on the SEC website (http://www.sec.gov/litigation/admin/2013/34-70694.pdf)
describes the unexpected activation of some legacy algorithmic trading code following a software
upgrade that was not deployed to all the servers as it should have been. The net result was a
gone rogue algorithm buying high and selling low that was not quickly identified and halted until
the firm had lost over $400 million dollars. The SEC report focuses on rule breaches and risk
management failures but does not really identify anything to stop these failures from occuring at
other firms; indeed since the failure of Knight Trading we have seen other algorithmic failures
including a Goldman Sachs
(http://www.bankingtech.com/161162/goldman-sachs-trading-error-is-a-warning-to-all/) algo
failure.
Trading technology on Wall Street is driven by a time-to-market ethos in an environment where firms are expected to adapt to changing markets and innovate new algorithms. There is a dangerous feedback loop with exchange innovation and regulatory changes that greatly limit system testing. SEC investigations have focused on identifying rule breaches and have not considered the technical fragility of the markets we have created. The SEC investigation into the “2010 Flash Crash” was widely regarded as very weak. The statement by SEC Chariman Mary Shapiro (http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171483674) issued shortly after the Knight failure making a very self-serving reference to improved controls indicates to me an organization that is struggling to understand market interconnections. There have been enough odd price movements to suggest that algo problems are a relatively common event that only get regulatory or press attention after a major failure.
Improving testing processes in trading firm technology departments can reduce risks but investing in testing rather than improving trading performance is difficult to justify to business management unless the firm has experienced a major failure. The SEC should be taking steps not only to prevent the failure of firms such as Knight but also to prevent future market disruptions. The introduction of capital limits at each exchange and applying the same SEC 15c3-5 "Risk Management Controls for Broker Dealers" to US Exchanges would provide a further level of protection for the market when an individual firm's control mechanisms fail.
Trading technology on Wall Street is driven by a time-to-market ethos in an environment where firms are expected to adapt to changing markets and innovate new algorithms. There is a dangerous feedback loop with exchange innovation and regulatory changes that greatly limit system testing. SEC investigations have focused on identifying rule breaches and have not considered the technical fragility of the markets we have created. The SEC investigation into the “2010 Flash Crash” was widely regarded as very weak. The statement by SEC Chariman Mary Shapiro (http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171483674) issued shortly after the Knight failure making a very self-serving reference to improved controls indicates to me an organization that is struggling to understand market interconnections. There have been enough odd price movements to suggest that algo problems are a relatively common event that only get regulatory or press attention after a major failure.
Improving testing processes in trading firm technology departments can reduce risks but investing in testing rather than improving trading performance is difficult to justify to business management unless the firm has experienced a major failure. The SEC should be taking steps not only to prevent the failure of firms such as Knight but also to prevent future market disruptions. The introduction of capital limits at each exchange and applying the same SEC 15c3-5 "Risk Management Controls for Broker Dealers" to US Exchanges would provide a further level of protection for the market when an individual firm's control mechanisms fail.
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Trading & Technology on Wall Street
Trading & Technology on Wall Street
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Knight Trading imploded because they
lost $400 million in an hour due to
'techincal' problem. Why should we
believe any other brokerage firm is
safe from a similar event...