Market watchers call for more thorough testing, measures to slow trading
The $440 mn loss by Knight Capital Group, one of the main market makers in the United States, in less than one hour of errant trades sparked by a technical malfunction, has renewed scrutiny on high-frequency trading.
Market analysts, politicians and other traders have made calls for changes to the system ranging from new regulations to prevent this type of damage and transaction taxes which would limit trading platforms that can buy and sell thousands of times in a single second, to more thorough testing of systems before they come into use.
Last week the SEC contracted a firm to collect real-time data from US stock exchanges in order to better police high-frequency trades. The technology is meant to allow the SEC to analyze data at intervals of one thousandth of a second in real time and enable some 100 SEC staff to make hundreds of queries a day.
The SEC also adopted its ‘large trader reporting regime’ last year to push for closer monitoring of high-frequency trading. The regime required large traders to register with the commission through special forms and imposed stricter reporting, record-keeping and monitoring requirements on them.
Many market watchers and regulators say preventive action is needed to avoid wild, unpredictable swings in the market and massive errant trading such as occurred with Knight, a company that executes an average of 4 mn trades per day.
‘The ability of regulators to do their job has never been weaker than it is today because of the failure of the oversight process,’ former SEC chairman Arthur Levitt Jr tells Bloomberg News. ‘Congress has a greater responsibility for what we’re seeing today than any regulator or any particular part of the industry. They’ve allowed this to happen.’
Knight’s errant trading, which took place on the first day the company was using a new trading system, also prompted calls for a system to ensure that software is well tested before it is put to use in live trading.
‘When they put these things out in the world they are really being tried for the first time in a real-life test,’ David Leinweber, head of the Center for Innovative Financial Technology at the Lawrence Berkeley National Laboratory, tells the New York Times. ‘For other complex systems we do offline simulation testing.’
Others, though, said the Knight error may simply represent a lack of monitoring in the company itself and does not point to a systemic problem within the modern trading system.
‘Every company in the modern economy relies on software to run its systems,’ says Rik Turner, a senior analyst at market research firm Ovum.
‘If Tesco had a major software problem that caused all its freezers to turn off in high summer, the loss from produce that had gone off would not have caused debate as to the supermarket’s overreliance on technology – though the company would probably have to explain to its shareholders why it didn’t have a decent monitoring system in place.’
Knight chief executive Thomas Joyce, in testimony to Congress less than two months ago, said the company is capable of processing as many as 20 mn trades per day and spends ‘tens of millions’ of dollars a year in optimizing the system.
‘Knight has spent the last 17 years evolving our technology infrastructure so that it can process millions of trades a day on behalf of the retail investor in a fast, reliable, cost-effective manner,’ Joyce said.
