FIX Protocol (FPL), the operator of the FIX financial messaging standard, has published a set of guidelines designed to establish best practice for electronic trading risk management.
The guidelines are the product of a group re-established in Q3 2010 by FPL to raise awareness on issues surrounding risk management for electronic trading and create a baseline set of industry-wide standards. The group comprises electronic trading heads from large sell-side firms.
The group was first set up before the financial crisis, when a panel of brokers discussed risk management practices for automated trading practices. The financial crisis curtailed the progress of the group until last year, when issues such as the 6 May ”flash crash’ and the proposal to ban naked sponsored access – whereby brokers allow their customers to use their infrastructure to trade directly on exchange without pre-trade risk checks – by US regulator the Securities and Exchange Commission, led to FPL taking a lead in reforming the group.
The risk control guidelines suggested by FPL relate to electronic orders sent to a trading venue using direct market access, sponsored access or via an algorithm.
The paper recommends that pre-order risk controls should include fundamental checks on the characteristics of a trade, including symbology validation, notional and average daily volume checks and price limit checks. While an order is being traded, brokers should check for favourable and adverse price moves, position limits and cumulative credit and capital checks. Pattern indicators should also be used to detect system anomalies such as order timing, repeated orders and cancel/replace ratios.
“Each broker has their own way of managing the risks associated with electronic trading, but as an industry, we thought it would be useful to codify these and agree on a set of best practices in light of recent market developments,” John Goeller, managing director, global execution services, Bank of America Merrill Lynch and co-chair of the FPL Americas Regional Committee told theTRADEnews.com. “These guidelines put a stake in the ground in terms of what firms should be aiming for and ensures all brokers are on an even playing field.”
He added that a separate buy-side working group had been established to provide further input into how the rules could be applied practically.
“While the sell-side are responsible for the implementation of risk controls, we believe the buy-side should also quiz their broking counterparts on their risk limits,” said Goeller. “We have already had some clients of Bank of America Merrill Lynch asking us to fill out the risk management matrix included in the paper on their behalf.”
The next step for the group will be to present the guidelines to the staff of the SEC and encourage input from other parts of the world.
“This is an evolving process and we hope to get more input from non-US market participants so that these guidelines are adopted on a global basis,” said Goeller.