Technology trials

As the technology underpinning the trading of financial instruments evolves, growing challenges for exchanges to safely implement change has created a market structure weakness.

Are exchanges able to cope with new technology?

Competition amongst exchanges has always had a technological element, but in the age of high-frequency trading (HFT) the role of technology has come to the fore. This has forced exchanges to compete for low-latency business through technological upgrades to shave fractions of a second from more message traffic on their systems. HFT is a natural consequence of the electronification of trading, which has given rise to complex algorithmic trading strategies used widely by market participants and co-location services from exchanges.

HFT, alongside algo trading, has developed mostly in the equities space, but is becoming increasingly relevant across asset classes. This has increased the complexity of trading and the volume of trades being carried out by machines. In turn, this could lead to delays in trading caused by rogue algos that may lead to erroneous fluctuations in stock prices that trigger exchange kill switches.

Kill switches were implemented in the wake of May 2010’s ‘flash crash’, when the Dow Jones Industrial Average experienced its biggest ever one-day point decline, dropping over 1,000 points only to recover minutes later. Kill switches would halt trading in a specific stock if it experienced major fluctuations in price, such as a rise or drop beyond a set threshold, such as 10%.

Is there enough regulatory oversight of technology underpinning trading venues?

In light of high-profile trading errors at the exchange level, regulators - particularly in the US where many of these glitches have taken place - have begun to shift their attention to infrastructure technology. Last week, US markets watchdog the Securities and Exchange Commission (SEC) met in private with leaders of US stock exchanges, including current leaders by market share the New York Stock Exchange and Nasdaq OMX. The meeting, chaired by SEC head Mary Jo White, was organised in response to a three-hour trading delay on Nasdaq earlier this month, which affected some 2,500 stocks.

White called upon exchange chiefs to explain how strong their systems were and to what degree failure is possible, and what effect more ‘glitches’ could have on US market structure. A core aim of the Commission is to ensure market participants are prepared for outages and mitigate the effects on US markets. 

The SEC’s systems focused regulation Reg SCI, which has been discussed in previous years and for which the SEC has sought industry comment, will soon move into the implementation stage, which will require, among other things, greater reporting requirements for exchanges to regulators. 

Which instruments are affected most?

The most high-profile glitches have occurred in the equities market, although the scale and global nature of the listed derivatives market means disruptions like that experience on the Chicago Board Options Exchange in August may become more frequent.

The creation of swap execution facilities (SEFs) to trade OTC derivatives may also face disruptions to trading as the instruments that will be transacted on these platforms are evolving from traditionally bilateral trading. So far, the Commodity Future Trading Commission has approved just three of the 16 platforms that have applied, ahead of the planned 2 October go-live date for SEFs to begin trading.