What About a Failover Switch? Kill switches are more appropriate to a broker dealer as in the case of Knight Capital trading situation, when erroneous orders were flooding the market, the firm wasn’t acting and the NYSE had no mechanism to halt the algorithm. ”That’s when you need a kill switch capability to shut down when something abnormal happens and trading shouldn’t be taking place,” says Edge.
At the broker level the SEC is going to want firms to identify a problem quickly and be able to stop trading. A broker that is not able to quickly identify an issue and stop trading is a reputational risk to the market, which can damage investor confidence. However, when exchanges shut down trading, that’s a systemic risk, he says. According to Edge, what exchanges need is more of a “failover switch” — the ability to migrate to a previous version of the system that works. It’s also a concern that the dark pools are using the same consolidated quote feed.
Given that the industry has had a number of incidents at this point – including erroneous options orders from Goldman Sachs two days before Nasdaq’s outage, and on Friday, CBOE Holding’s C2 options exchange and CBOE Stock Exchange were halted for more than half an hour each— regulators are going to say the industry has had enough warnings signs.
“I look at the pattern of events and while they are not correlated they are the potential risks are increasing and the frequency is increasing,” said Edge.
Drawing an analogy to someone who is five pounds overweight and has high cholesterol, Edge says this person can improve their fitness by going to the gym an hour a day. But if this person ignores the symptoms, and simply buys a larger size of pants, then the problem will get more serious. “We could have a heart attack in capital markets if we don’t start remediating these chronic issues now,” says Edge.
Ultimately, to ensure that technical glitches don’t disrupt trading and become more serious, Edge suggests that exchanges need to work on their processes and procedures and if systems changes are made, they have to be able to recover very quickly, he says. “In an automated and interconnected world, we have to make sure that our surveillance controls keep up,” says Edge. The top technology people in exchanges are not saying this is impossible.
However, Kill switches and failover switches will require a significant investment, says Edge. The technology groups within the exchanges are very competent he says, but they will need more staff, more procedures and more technology controls. They will need to reallocate money into this are, and come up with a plan. “It’s not splitting atoms,” says Edge.