FIX Protocol Limited (FPL), the trade association that sets the de facto standard for trade-related messages sent electronically among market participants, is looking to stop inadvertent — but potentially market-distorting errors — by brokers with an update to its risk control guidelines. FPL originally released in spring 2011 a dozen recommendations outlining basic ways in which brokers could prevent bad trades, but the organization announced in June an update to those guidelines created at the behest of buy- and sell-side firms as well as exchanges.
The original risk control guidelines include calls for more scrutiny of large orders by brokers to ensure that they aren’t actually fat-finger mistakes, the validation of an order’s symbol to make sure the correct stock is being traded, and checks to ensure a fund manager hasn’t accidentally duplicated an order.
[Click here to view images of Knight Capital Group's trading floor.]
The update, which also was driven by the increasing complexity of trading strategies, includes more details on how risk should be managed between a buy-side firm and its broker. For instance, FPL now says a broker isn’t immediately required to accept all orders from buy-side clients, and that it should employ risk checks to flag orders that exceed either its own internal risk thresholds or those of the client.
“The reason we want to check for an order that’s entered in error or exceeds any kind of risk tolerance is to prevent an erroneous order from trading large volume in an illiquid name and driving the price in a particular direction,” says Neal Goldstein, who serves as both the co-chairman of FPL’s Americas Risk Management Working Group and as JPMorgan’s global head of electronic connectivity solutions. “When there’s an error on an input to an order, then there is potential for an outcome that is not what the client intended.”
Should a buy-side order breach a broker’s pre-determined risk limit, FPL says, the broker should pause it within its system and then fire off a message to the client explaining that the order is suspended in a “pending” state, with some detail on why it was paused. This recommendation, however, could force buy-side firms, or their third-party technology providers, to update their order management systems. The trade group says most of the OMS platforms being used across the buy side don’t feature this type of pending message functionality, though it adds that communicating by phone with a broker is an alternative.
“Currently there are gaps in the way that the marketplace operates around pausing orders,” Goldstein explains. “We’re looking to add a communication structure around what happens when an order has been paused prior to acceptance, so that the person on the other end at the client level doesn’t get concerned, cancel the order and send it someplace else before both sides can validate the order.”
A Positive Influence
Nevertheless, industry sources say, if the new guidelines gain widespread acceptance, they’ll go a long way toward making the markets more stable. But because FPL is not a regulatory body, its guidelines are not enforceable.
“The goal of the [FPL risk guidelines] was to identify best practices and make recommendations,” says Timothy Furey, who serves as the co-chairman of FPL’s Americas Risk Management Working Group and as global chief operating officer of Goldman Sachs Electronic Trading (GSET). “Because broker-dealers come in different shapes and sizes, the recommendations were designed with some flexibility as opposed to forcing people into boxes.”
Noting that FPL’s efforts are a step in the right direction for the industry, Ian Domowitz, the head of ITG Analytics, says the trade group eventually could help steer policy at the regulatory level. “One of the things that FPL can indeed do for us all is to help influence policy in a way that’s both effective and cost-effective,” he comments, adding that he ultimately expects full implementation of the guidelines throughout the broker-dealer community.
John Bates, the founder and chief technology officer of Progress Software, contends that although brokers can’t be forced to heed these guidelines, the ones that do are likely to wield great influence on their counterparts. “People are going to ask, ‘Well, do we do this?’” Bates predicts. “As a minimum set of things that a peer community is pushing, it could be good.”