The UK’s financial market regulator, the Financial Conduct Authority (FCA), yesterday released a detailed report on the supervision of algorithmic trading including new requirements under the MiFID II guidelines. The report touches on the key issues of emphasis and good and bad practices observed within cross-firm reviews.
The introduction of automated trading technology has brought significant benefits to investors, with increased execution speed and lower costs. However, it has also introduced a certain degree of risk in terms of compliance and management. It is therefore essential to have oversight functions in place to keep pace with the technological advancement in algo-trading – a double-edged sword in the trading world. The absence of any such systems and controls can turn a manageable error into an extreme event, possibly affecting millions of other investors.
Consequently, the FCA has initiated a detailed report to explore this area – an area that has gained prominence with the advancement of trading technologies within the industry. Megan Butler, Director of Supervision, Investment, Wholesale at the FCA, said in the report:
This report is relevant for all firms developing and using algorithmic trading strategies in wholesale markets. Firms should consider and act on its content in the context of good practice for their business.
The report focuses on the five key areas within algorithmic trading compliance in the wholesale markets: Defining Algorithmic Trading, the Development and Testing Process, Risk Controls, Governance and Oversight, and Market Conduct. The report also includes a detailed assessment of procedures used by firms involved in algorithmic trading, their front line staff, including traders, research analysts, and software developers.
Overall, the report presents a positive attitude from those within the industry towards the need for measures to reduce the potential risks in algorithmic trading. The report also suggests that staff involved in the development and implementation processes should undergo “market-abuse training” as a means of reducing potential conduct risks.
The FCA also highlights a number of key requirements firms need to be particularly aware of in order to comply with the MiFID II guidelines. These includes emergency “kill functionality” to cancel all unexecuted orders with immediate effect, a robust trading system to prevent incorrect orders contributing to a disorderly market, and business continuity arrangements to deal with system failures.
The Prudential Regulation Authority (PRA) has also released a consultation paper on the subject, covering the governance and risk management of algorithmic trading. The FCA and PRA will continue to work closely together going forward.
