The Financial Conduct Authority (FCA) is worried about “inappropriate” trading algorithms causing trouble in financial markets.
FCA CEO Andrew Bailey said at a press conference on Wednesday: “It’s very important to focus on how algos are used. It’s one thing having a badly programmed algo. I think from experience a bigger issue is the inappropriate use of algos.
“Using in an algo in market conditions when you shouldn’t, when the market is too thin and you need to exercise human judgment — that’s one example.”
“Algos” is the term given to algorithmic trading programmes — computer programmes that carry out trades in the market for people. These can be programmed to do all sorts of things, from buying or selling a certain stock once a given price is reached to gradually selling down a holding to make sure you get the best price.
Their existence was widely popularised by author Michael Lewis, who wrote The Big Short, in his book “Flash Boys.” The book focused on high frequency traders, which use algos to make trades in milliseconds, and was heavily critical of how algos are used and policed.
Algos have also been in the headlines for the wrong reasons recently after the pound was hit by a so-called “flash crash.” The pound crashed over 6% in 2 minutes earlier this month, with market participants blaming algos.
The pound broke through a certain level, triggering some algorithms to automatically sell. But thin trading volumes — there were not enough buyers — meant the impact of the flood of sellers was outsize and created a downward spiral as the slump triggered more algorithms to sell.
Bailey did not mention the flash crash directly but his comments on volumes appear a strong allusion. Bailey also highlighted the Swiss franc being de-pegged from the euro. This policy decision from the Swiss central bank send the Euro plummeting almost 30% against the Swiss franc.
Bailey said: “Go back to the Swiss franc de-peg for example. One of the big lessons out of that was how to firms react when that sort of thing happens? Sometimes you go into firms and they say we pull the plugs out at that point — I think that’s a metaphor. You go, well that’s great, but what do you do next in terms of the management of your positions and the management of your algos?
“When we were doing the planning for the UK referendum we spent a lot of time on this question. Had we had a big gapping (big price moves without trading) markets, we were very sensitised to: do firms understand their trading controls properly?”
Meghan Butler, the FCA’s director of supervision, added: “We do not investigate the individual operation of each algo or approve it or anything of the sort. I’m not aware of any regulator that does do that. It’s an interesting point to raise, it’s a live conversation among regulators at the moment.
“Our approach on those is to recognise that a poorly designed, poorly controlled, inappropriately used algo can have a very significant negative impact on the proper operation of the market. Our intention in that area…. is we seek to ensure that the organisations that design them and use them, and indeed sometimes sell them on to third parties, do so in an appropriately controlled manner, so that they understand it and can control it.”
Butler said that, as per the FCA’s senior managers regime, at least one executive had to be on the hook for everything going on in the business, including the programmers creating and deploying the algos. That means they can be punished for rogue or inappropriate algos.
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