The Australian financial markets regulator has put tougher oversight of brokers’ order processing systems at the heart of proposed guidelines to protect investors against the flash crashes and outages that have bedevilled other equity markets.
On Monday, the Australian Securities and Investments Commission (ASIC) published for consultation new rules and guidance on automated trading as part of ongoing reforms to the Australian equity market structure.
The proposed new framework, known as Consultation Paper 184, includes rules requiring market participants to implement filters and other controls to suspend trading, revised processes for certifying systems that release orders into the market and new guidance on the testing of systems and controls used to support automated trading. ASIC’s outlined changes would require reviews of system changes “at least yearly” and demonstration of the ability to handle highly automated trading and stress testing of order flow.
Subject to revision following the consultation process, the new rules will require market participants to exert direct control over pre-trade filters and to “suspend, limit or prohibit an order or series of orders” from an automated order processing (AOP) system in real time. This places responsibility clearly with the market participant, i.e. the exchange member, rather than the client. The new rules also toughen up oversight of AOP systems by requiring a more stringent audit trail for initial certification, implementation of material changes and annual reviews.
Noting that ASIC’s fourth report on the supervision of Australian financial markets, also released on 13 August, highlighted issues relating to the growth of high-frequency trading (HFT), deputy chairman Belinda Gibson said HFT “and algorithms generally” were a cause of concern.
“Recent events overseas are a reminder of the speed and automation of markets and the importance of robust controls over those systems. The enhancements to participant-level controls … will build confidence in the integrity and cleanliness of our capital markets and facilitate international capital markets,” said Gibson.
On 1 August, a problem with a system upgrade caused US market maker Knight Capital to send duplicate orders to the New York Stock Exchange, resulting in a US$440 million loss for the firm. The glitch, which follows technology-related problems earlier this year with the listings of social networking site Facebook and exchange operator BATS Global Markets, comes despite measures implemented by US regulators after the 6 May 2010 flash crash, including tighter pre-trade controls, market-wide circuit breakers and the introduction of a consolidated audit trail.
ASIC’s proposals are open to consultation until 14 September with market integrity rules and regulatory guidance expected to be released in October. These participant-level rules on automated trading follow draft market level controls released in June as part of the regulator’s Consultation Paper 179, ‘Australian market structure: Draft market integrity rules and guidance’. The paper outlines ASIC’s approach on market operator systems and controls, extreme price movements, enhanced data for market supervision and pre-trade transparency. The consultation closed on 6 August and final rules are slated for release in October.
“We expect investors, issuers, market participants and market operators to benefit from greater protection against the risk of aberrant automated trading disrupting Australia’s equity markets by raising expectations for testing of AOP systems filters and controls,” said ASIC. The watchdog acknowledged that market participants which do not have the necessary controls in place would “incur some cost in building the capability” and that the cost of system and process changes “may be material”.
Liam Madden, agency broker Instinet’s head of compliance for Asia, welcomed the consultation but also stressed the importance of defining terms of reference. “Benchmark algorithms (such as VWAP and volume participation algos) are totally different to ‘black-box’ algorithms used by high-frequency traders,” he said. “It is only once these definitions are clearly laid out that we can really hope to create an environment conducive to constructive comment and effective regulation in this space.”