Trading Risk the Focus of New FPL Committee
Effort under way to establish best practices for bad trades
December 15, 2008
Amid dramatic volatility, FIX Protocol Ltd. (FPL), the governing body for the buy-side-to-sell-side messaging protocol, has formed a risk committee to address growing concerns among market participants and trading venues.
Problems stemming from erroneous trades and order validation are at the top the group's agenda as it seeks to establish industrywide best practices for a range of risk-related trading issues. Such difficulties came to the fore, according to committee members, on Sept. 19, when tens of thousands of bad trades were removed from the consolidated tape.
The risk committee, which includes executives from Barclays Capital, Fidelity Capital Markets, Goldman Sachs, JP Morgan Chase & Co. and Merrill Lynch & Co., was put together in July and announced at an FPL conference in New York late last month. Highlighted at that event was the lack of uniformity in the way exchanges deal with trading errors and financial firms' increasing desire for guidance.
"In today's trading environment, things can go off the rails much faster than before," said Greg Tusar, Goldman's head of electronic trading in North America, at the conference. In an interview, Tusar, a member of the risk committee, added that "market structure has changed a lot--in many ways for the better-but it has also made trading more risky." With automation comes faster trading speeds, along with fewer opportunities for firms to determine whether a transaction is valid, he said.
Fellow committee member Tom Jordan, president and CEO of New York-based consultancy Jordan & Jordan, noted that when a sell-side firm decides a trade is erroneous, a buy-side client who stood to profit may feel otherwise. The situation is exacerbated, said Jordan, by trading venues' differing rules about what constitutes a bad transaction and how quickly a complaint must be lodged for a trade to be broken. And because algorithms react instantly to a trade, erroneous activity on one venue can affect a dozen others.
"Execution centers [need] to use the same criteria for defining an erroneous trade," asserted Jordan. Both trading venues and regulators are looking closely at the issue, according to John Goeller, director of portfolio and electronic trading at Merrill Lynch and head of the FPL risk committee's risk technology working group.
In response to criticism, officials from NYSE Euronext, Nasdaq OMX Group, BATS Trading and Direct Edge told attendees at the annual Security Traders Association convention in October that they will work collectively to shape consistent rules that offer clarity to sell-side firms. However, the sell side also needs to assess internal controls, according to Goeller. "Most sell-side firms have looked at the issue of proper controls to protect against erroneous trades," he said, adding that many have implemented controls related to order validation.
The risk technology group is working to standardize the handling of order criteria checks by identifying a set of guidelines for firms to apply to their trading platforms, said Goeller.
According to Goldman's Tusar, the committee wants to establish best practices for flagging an order when it is too large or outside a client's normal range of activity--or is transmitted multiple times.
"While the problem of an erroneous trade--someone putting an extra zero on an order, for example--is not new, the propensity for it to happen has increased and the buy side is now much closer to this problem," said Tusar. "Quite a few" Goldman clients have asked how they should prevent staff from accidentally trading outside of an order, he added. As a result, Goldman has developed software that "allows us to calibrate on a client-by-client basis what constitutes a suitable order for a particular client, including average order size, type, average daily volume, client historical activity levels, etc."
