Advanced Trading: You have a solution called ExpressWay E-Brake that allows brokers to either automatically or manually stop a trade after it's been executed. Are any brokers using this kill switch today?
Michael Chin, Mantara:
Michael Chin, Mantara:It is being used as a result of the brokers who are offering sponsored access and who are responding to regulators and the SEC Rule 15c35. Over the years that this rule has been enforced, the focus has been to target the responsibility for the sponsored access broker to put pre-trade checks on behalf of end-users such as hedge funds, HFT firms, prop shops. Our focus on this product has been on the buy side.
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Advanced Trading: Does a buy side firm buy this tool or is this provided by the brokers?
Chin:The brokers offer this to the buy side as part of their offering access and connectivity to the markets.
As you saw with the Knight Trading episode, the sell side has not focused on automated trading strategies internally but when it comes to market making, it relied heavily on automated trading strategies. The Knight Capital issue has highlighted that these strategies can run amok and cause the same repercussions to the market that the SEC was trying to resolve by putting more parameters and brakes around sponsored access. The sell side has been slow in adopting their own internal controls.
We have two clients that had the foresight to build this particular product for their own use and in ways that would have prevented these runaway algos to a client that hadn't incorporated them.
Advanced Trading: Who's responsible for hitting the kill switch - the broker or the buy side client?
Chin:In this setup, it is for the sell side or the broker. Based upon seeing that their risk parameters have been broken, they would either manually kill the connection or have it built into the system where the system can automatically kill the session.
Advanced Trading: Does it kill the entire trade or the portion of trade that has not been executed?
Chin:It kills the connection that sends the trades down to be executed. The ones that have already gone down to the exchange would still be executed. So, it's only killing any further orders to go down to the exchange to be executed.
Advanced Trading: So it's not a human being hitting a red button?
Chin:It can be done on two different set ups: automated and someone who is viewing our monitoring screen, a risk GUI we call a Navigator screen, and if they see the violation of these risks parameters through the GUI, they push a button that can manually kill it.
What we do for the manual option, the client sets the risk parameters but they put in a buffer in that allows them to see if their risk parameter is getting close to 80 percent being violated. They can view it, monitor it a little more closely and then make a decision on whether they are going to manually kill it or they are going to let it go through.
Advanced Trading: Have your brokerage clients actually used the kill switch?
Chin:We don't know. They both have an enterprise set-up so we wouldn't know if they have deployed it or not. An enterprise set up is really contained in their data center and infrastructure. We do know that they have put this in place for exactly the reasons that they wanted: to handle such situations as last week.
Advanced Trading: I would assume that a firm as smart as Knight Capital would have a kill switch in place. Am I being naïve?
Chin:No, because a lot of other people made that basic assumption as well. As more facts come to light, it seems that the news is focused on the simple fact that they did not have a way to kill this algo or the connection to the market to stop this trade from going down.
People are focusing on this 45-minute period that they knew things were going awry but they weren't able to respond for 45 minutes to make any decisions. This is leading people to believe - and I think there are more facts coming out - that it was a matter of not being able to kill the strategy in a very easy way.
Advanced Trading: Why - because the strategy was so complex and widespread? It wasn't a simple order like "Go out and buy 10,000 shares of Dell"?
Chin:No, it was buying and selling and there were two different names [that were repeatedly used] and to be very honest, I don't think that there was a lot of visibility on certain risk parameters that could have identified these issues. One of them would have been if they were trading a percentage over average daily volume – that alone was [a sign] that they were trading enormous amounts of names [and] it got to a point where it was representing a large average daily volume. That would have triggered a risk flag that would have identified that [situation] early on.
Advanced Trading: What else do you think happened?
Chin:Other things would have been doing a check on duplicate orders because they were doing the same names over and over again. If they had a check in place that would have identified a pattern of trading of duplicate orders that would have triggered something that would have identified this issue earlier on.
From what I can tell, it was a lack of visibility into the overall - not the trades themselves - but that aggregation of these trades and not being able to see the result of multiple trades.
Advanced Trading: Do you think that we will see more runaway algos in the future? Could there be a repeat of what happened at Knight Capital?
Chin:That's a tricky question. There's going to be some reactions from the regulators that I believe will start including similar types of managing real-time risk somewhat in the way that they are asking the sell side to provide to the buy side for HFT firms. I think that the sell side will have to comply with these types of regulations and risk requirements.
That said, there will be a heavy internal compliance audit of these automated trading strategies and market-making trading strategies that are inherent in a number of firms on Wall Street and across the world. People will be quick to adopt some internal controls and solutions. I think that people are going to be very conservative about how they approach this going forward. They need to gain back the confidence of the investors and are putting real time checks across these strategies. This is a wake-up call for all the market participants.
Phil Albinus is the former editor-in-chief of Advanced Trading. He has nearly two decades of journalism experience and has been covering financial technology and regulation for nine years. Before joining Advanced Trading, he served as editor of Waters, a monthly trade journal ... View Full Bio