Greg Wood, Deutsche Bank’s director, and head of algorithmic execution for listed derivatives and foreign exchange in the Americas, and FPL director, recently sat down with WS&T to talk about kill switches and other hot button issues that were included in the FPL’s recent industry guide on risk management.
WST: What were the most hotly discussed issues of the new risk guidelines?
GW: One thing that provoked much discussion was the concept of “pausing” an order when it fails a risk check on arrival at the broker. It is important to note that brokers would never pause an order sent directly to market if it fails a risk check – those orders need to be rejected immediately. However in certain situations orders that are routed to a broker’s execution algorithm can have more time before they start trading, particularly if they are equity orders sent before the open. This allows the broker to pause the order while they understand the reason behind the risk check failure. Once that is understood, the broker accepts or rejects the order accordingly.
WST: What are some of the other highlights of the new guidelines?
GW:We introduced an additional FIX message that allows us to communicate when an order has been paused. It’s an evolution of what brokers have been doing for several years. Most equities brokers have someone on the desk that picks up the phone to the client and reviews an order that fails a risk check. Current practice when an order is paused at the broker means that the client doesn’t know if it’s been accepted or rejected without that phone call. We’ve added an extra tag/value within the “Pending New” message to denote that the order has failed an algo risk check. This is sent back to the client’s system and the order’s state will be changed to “paused”, as opposed to leaving it in limbo. This electronically alerts the client of what has occurred.
WST: What happens when a client receives an alert?
GW: Either they contact the broker or more likely the broker will contact them. As noted before, brokers will only use a pause message in particular situations: i.e. if the order exceeds a certain limit when we know the timeframe for execution is not critical. If an order was due to execute immediately it would be cleanly rejected.
WST: So most of these new safeguards are to prevent inadvertent trading?
GW: The idea behind risk management checks that act as “speed bumps” is to identify whether a client may be overtrading. If the check fails, the speed bump kicks in and slows or stops activity until it can be confirmed whether it is intended or not. Many clients like such checks being in place. It’s a safeguard for both them and the broker. We believe that there should be risk management checks in every part of the electronic order flow that is practical. The client has a responsibility to put in checks. The broker has a responsibility to put in checks. The exchange or venue also has a responsibility to put in checks to maintain market integrity.
WST: What will the next set of risk management guidelines focus on?
GW: The FPL group - amongst other things - will look at kill switches and see how they can be applied in a pragmatic way. We will also be looking at standardizing FIX messages to convey limits and risk management events between different parties – for example between the broker and the client, the broker and trading system vendors, or the broker and trading venues. Brokers need to look at this pragmatically since there are clients who have their own direct connectivity to venues and there are clients who share a broker’s connectivity. The broker needs to be able to shut off different types of order flow in a controlled way.