In today's fast-trading environment where automated strategies are often up against one another, brokers' ability to implement real-time risk management tools has become all the more crucial, says Murat Atamer, head of AES product, Asia Pacific, at broker Credit Suisse.
In the third quarter of 2010, FIX Protocol Ltd (FPL), the operator of the FIX financial messaging standard, launched a group to raise awareness regarding the implications of electronic trading on risk management and to develop standardised best practices for industry consideration. In January 2011, FPL announced the completion of an initial set of guidelines recommending risk management best practices in electronic trading for institutional market participants. Over the last few months, the group, which consists of representatives from major sell-side firms, has been working on developing the guidelines to encourage broker-dealers to incorporate a baseline set of standardised risk controls.
In recent months Credit Suisse has launched its own set of electronic safeguards designed to detect and contain risk on its trading platform. According to Atamer, Credit Suisse was already fully compliant with the checks recommended by the FIX protocol committee at the time of the release, and the bank has gone further to address the risk management needs through cutting edge technology.
“These [FIX] recommendations do not fully cover real market impact checks especially from market orders (orders that have no limit price). To truly prevent large market impact due to fat-finger errors, one has to look at the real-time available liquidity in the order book with the size of the order in mind. Static percent average daily volume and notional checks are not enough,” Atamer said.
Although brokers generally apply their own internal risk checks, FPL felt it would be beneficial to market participants to define a standardised set of guidelines for the industry. The scope of risk controls included in the guidelines is for electronic orders delivered directly to an algorithmic trading product, or to a DMA trading destination. The guidelines are designed to systemically minimise the inherent risk of executing electronic algorithmic and DMA orders.
“It is getting harder to trade Asian markets manually as liquidity displayed in best bid and offer prices as well as the typical trade sizes has halved compared to three years ago; with the launch of Tokyo Stock Exchange's arrowhead, the change in Japan is even more drastic,” Atamer noted.
He adds that institutional investors need to trade electronically not only because algorithms offer increased efficiency, but also because they are increasingly becoming a part of their core competency, to source liquidity from multiple venues with minimal footprint. “As a result, more often than not, algorithms can be up against other automated strategies rather than human traders. As such, safety as well as signaling risk is of more importance,” he added.
“Additionally, it was often thought that the market is efficient, and that other traders in the market are rational. We have all seen in some of the most developed markets that these assumptions are flawed. It’s clear that errors do happen and the market does not always react rationally.”
The new premise that markets are not always rational has been behind one of the biggest enhancements to Credit Suisse's platform, according to Atamer. “Now, regardless of the fact that we are trading on the opposite sides or on the same side of the book with another algorithm or human trader, the AES True Price Technology will assess sizable price moves and completely disengage the algorithm from trading when the market temporarily moves against our clients. Additionally, if the adverse price movement is permanent, the algorithm will re-engage without compromising on completion rates,” he explained.
The next level in the development of such risk management capabilities would be to customise these according to individual client's needs, he added.
Author: Jill Wong