Do Markets Need More Errors?
October 2, 2012
Glitches that lead to disruptions in trading such as the Flash Crash of 2010, the failed BATS IPO in March, the flubbed Facebook IPO in May and the flood of erroneous orders from Knight Capital in August are inevitable, a panel of operations and technology executives told the Securities and Exchange Commission Tuesday morning.
The challenge is for the industry to develop skills and practices that anticipate and remediate as many potential errors as possible, as the number of interrelated venues, algorithms and order types proliferate, said members of the market technology roundtable convened by the SEC in the wake of the Knight event.
“We have to accept that errors are inevitable, and instead create a prevention culture,” noted Sudhanshu Arya, managing director and global head of liquidity management technology at Investment Technology Group (ITG). “Software errors will happen, but it is more important to contain the cascading affect and the double-failures that spread the problem throughout the market.”
In fact, there may not be enough errors as it is, on which to build industry-wide prevention systems, said Dr. Nancy Leveson, Professor of Aeronautics, Astronautics and Engineering Systems at the Massachusetts Institute of Technology (MIT).
The rarity of software breakdowns actually hurts efforts at prevention because much can be learned when broken systems have to be fixed. “If that occurs just every six months or so, it’s not often enough,” she said.
The panel examining how to prevent errors through system design and operation was hosted by Robert W. Cook, Director of the SEC’s Division of Trading and Markets. The trick is to foster an environment of mutual protection that keepts one firm’s or one exchanges’ software flaw from provoking a ripple effect that could halt trading midstream or cause a market meltdown.
Such an environment could be created by making the business side of a firm or exchange aware of the complexity of their software requests and engaging in rigorous testing and risk assessment of new software, in advance of its use in live markets, the panelists said.
Jamil Nazarali, head of execution services at Citadel LLC, said it is vitally important to think of the entire chain of events that leads to a breakdown in the system, rather than examining only where the fault might lay in a particular software program. On August 1, the day of the Knight Capital problems, the first five minutes of the problem were due to the software, but the following 35 minutes were due to the software not being shut off, Nazareli said, and that is a problem of risk management and control.
“Had that been done,” he notes. “We would not be here right now.”