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Risk Management: In the Eye of the Storm

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Keep Out, At Your Own Risk

December 15, 2010
By Tom Steinert-Threlkeld

The first is the May 6 Flash Crash, where the value of the Dow Jones Industrial Average fell hundreds of points in a matter of minutes, in a series of events that took six months to start to untangle.

That series of events was triggered, the SEC and the Commodity Futures Trading Commission said, by a program launched by a “large fundamental trader” to sell a total of 75,000 E-Mini contracts valued at $4.1 billion. The automated algorithm was programmed to sell E-minis at a rate set to “9 percent of the trading volume calculated over the previous minute, but without regard to price or time. “

As a result, “the Sell Algorithm chosen by the large trader to only target trading volume, and neither price nor time, executed the sell program extremely rapidly in just 20 minutes,’’ the regulators said.

In this case, the Risk Management Gateway might have prevented the selloff at market-disrupting rates. But it just as easily might not have.

Because the gateway only follows instructions set by the broker or other party using it. If a broker sets limits on trade size, prices to be paid and the like, the gateway will execute the controls. If left open, they’re left open.

A second incident cited by SEC chairman Mary L. Schapiro at the Securities Industry and Financial Markets Association annual meeting in November involved an order that she said caused a “huge disruption” to equities markets, without the fanfare of the Flash Crash.

Without naming the stock or the date, she said the disruption was caused by an algorithm that tried to execute trades involving 10 percent of the average daily volume in a particular stock in just two seconds.

In this case, a disruption can be prevented fairly easily, using time and volume limits. “The broker sets that up,’’ said Tuskey. “We give them the tools to enforce that.”

In fact, the gateway not only fills broker needs’ for trading risk checks, the system helps them establish effective, documented procedures and controls.

“I could give you all the tools in the world, but if you don’t set them or use them right, I don’t think there’s anything I can build for you that if you don’t use it properly is going to work effectively,’’ said Boytim.

Risks are not managed for brokers only at Mahwah. Copies of the Risk Management Gateway have been put at the Savvis data center in Weehawken, N.J., which hosts the Z and Y exchanges of BATS Global Markets; the Equinix data center in Secaucus, which hosts the EDGA and EDGX exchanges of Direct Edge; and, a Verizon data center in Carteret, which hosts exchanges for Nasdaq OMX Group.

Plus, over the next two years, copies of the RMG will be installed at a variety of Savvis, Equinext, Telx and other data centers worldwide. As many as 40 “liquidity” hubs will rollout over that time, as extensions to the exchange operations housed in Mahwah and a sister center in Basildon, England, according to NYSE Technologies chief executive Stanley Young.


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