Fragility of Financial System Exposed

Threats abound from financial terrorism to rogue trading.



As regulators on both sides of the Atlantic try to come to grips with high-frequency and algorithmic trading, a sense of urgency has entered the discussion owing to the fragility of the financial system and its exposure to threats.



“So much of our economy is underpinned by electronic trading that protecting the market is more important than guarding Fort Knox,” John Bates, chief technology officer at Progress Software, told Markets Media. “But to keep up requires a different kind of regulation - a mandate for technology which can help to spot and manage these issues."



There needs to be increased regulatory oversight given the potential for a market crash, and given the increasing correlation of instruments and asset classes, Bates said.



"We fully support the SEC in its efforts to monitor electronic exchange trading and to be able to step in when things go awry.” Bates said. “ If regulators, exchanges and MTFs deploy better central monitoring and surveillance systems, then regulators would be able to see major price and volume spikes, how often they happen and maybe even why, and whether a pattern in market behavior is cause for alarm.”



Concerns over flash crashes, rogue traders, rogue algorithms and inside trading mount as the speed of transactions continues to increase.



“While most of the algorithmic and high frequency trading participants are ethical, there are a few bad apples manipulating the market at high speed and potentially hiding their activities across different trading venues,” Bates said. “Our concern is that a well-funded terrorist organization might use such tactics to manipulate or cripple markets.”



Large order volumes, numerous cancellations, short position-holding periods and ending the day with largely flat positions are all by-products of HFT, although they have come to be associated with it, according to Bates.



“I do not believe that these practices define HFT, but they do require careful policing to in order to prevent market abuse,” he said.



Regulators in the U.S. and Europe have been wrestling with how to treat HFT and automated trading in general. In the United States, the SEC and CFTC are considering whether to impose requirements on HFTs to function as market makers.



The CFTC’s Scott O’Malia has proposed a multi -part test to determine what constitutes an HFT, such as the use of extraordinarily high-speed order submission systems with speed in excess of five milliseconds; the use of computer programs or algos for automated decision making, without human direction for individual trades or orders, and very short time-frames for establishing and liquidating positions.