* Says more controls would have helped contain losses from
* Finds firms fail to implement many risk controls in name
* Calls for automated risk controls at every step in trade's
Sept 17 The increasing number of technological
snafus at exchanges and trading firms highlights the need for
more stringent risk controls at all levels of the high-speed
trading cycle, the Federal Reserve Bank of Chicago said on
On Aug. 1, a trading glitch that punched a $440 million hole
in Knight Capital Group Inc's balance sheet and nearly
sank the firm is likely to prompt a review of the rules that
govern electronic trading.
There are a number of risk controls that could have helped
contain Knight's loss, the Chicago Fed said in a letter.
Such measures include a limit on the number of orders that
can be sent to an exchange within a specific time frame; a "kill
switch" that could stop trading at one or more levels; and
profit-and-loss limits that restrict the dollar value that can
be lost, it said.
Researchers at the Chicago Fed interviewed representatives
of more than 30 technology vendors, broker-dealers and futures
commission merchants (FCMs), proprietary trading firms, and
exchange and clearinghouse professionals for a study on keeping
markets safe in the era of high-speed trading.
They found that many firms fail to implement all the risk
controls recommended by industry and regulatory groups, or rely
on other firms in the trade cycle to catch out-of-control
algorithms or erroneous trades.
"In part, this is because applying risk controls before the
start of a trade can slow down an order, and high-speed trading
firms are often under enormous pressure to route their orders to
the exchange quickly so as to capture a trade at the desired
price," the letter said.
Chicago Fed staff said they found out-of-control algorithms
were more common than they had anticipated, and that while there
were no clear patterns as to their cause, there were ways to
lessen their impacts.
"There should be automated risk controls at every step in
the life cycle of a trade with human beings overseeing the
process," the letter said.
Nasdaq OMX Group is currently under investigation
by regulators for its botched handling of Facebook Inc's
May 18 initial public offering. Also earlier this year, BATS
Global Markets suffered a technology glitch that led it to pull
its own IPO on its own exchange.
The Chicago Fed study found that corners are sometimes cut
in the name of speed.
At broker-dealers and FCMs, there is pressure to check
customer orders as quickly as possible before sending them to
To accelerate order submissions, some firms rely solely on
the pre-trade risk checks done by exchanges. But those risk
controls might not actually stop erroneous orders from being
filled, the researchers found.
They also found that many trading firms that build their own
trading systems apply fewer pre-trade checks to some trading
strategies than others in order to speed up their processes.
Other areas of concern in the study included attention paid
to processes for the development, testing, and deployment of
code used in trading algorithms, as well as conflicts that could
arise from some high-speed trading firms owning stakes in
The study recommended that regulators work with the industry
to define best practices and to audit firms' compliance with
"At the very minimum, it is critically important that each
firm involved in the life cycle of a high-speed trade has its
own risk controls and does not rely solely on another firm in
the cycle to manage its risk," it said.
The SEC has scheduled a roundtable discussion for Oct. 2
with industry experts on the prevention of technological errors
and ways to address them when they do occur.