Brokers are fretting unnecessarily, says Steward

The executive director of the SFC's enforcement division, Mark Steward, tells a forum in Hong Kong that proposed risk-control rules on algo trading are less invasive than feared.
Brokers are fretting unnecessarily, says Steward

The broker community is unnecessarily fretting over proposals by Hong Kong’s SFC to impose new risk-control rules on algo trading, the regulator’s Mark Steward has assured a forum.

Speaking at the Trading Architecture Asia event in the city late last week, the executive director for the SFC's enforcement division notes that brokers will only be held liable for sending an aberrant algorithm to the market if they had “a high degree of knowledge” about the client’s trading intent.

It is not that the Securities and Futures Commission (SFC) requires brokers to have a crystal ball when it comes to client intent on algo trading, but that “the degree of knowledge that needs to exist is very high…it is almost saying that the intermediary itself is participating in the conduct [of the client]”.

Hong Kong has joined other jurisdictions such as those in Australia and India in setting up a new supervisory legal framework for algo trading, with consultation in progress on placing greater onus on intermediaries to monitor the risk of electronic trading. 

Asia lags the US in particular in its adoption of algo trading, while high costs and market structure issues such as settlement delay have kept high-frequency traders away from many Asian cash equity markets.

But market-maker Knight Capital’s aberrant algo in the US this summer, which resulted in losses of $440 million to the firm, following on from the flash crash in May 2010 have heightened regulatory scrutiny of this area globally, including in Asia.

Steward’s aim was to sooth concerns over the proposed onus on brokers, saying that for the most part they would not have enough information to assess what the order was doing or what the clients’ intent might be.

“If an intermediary has additional knowledge about a client’s purpose, in combination with receiving the order, [but] does not proceed to join the two together and ask questions [of its client],” then the broker would be subject to investigation by the regulator, he said.

The broking community has pushed back against planned SFC rules to impose pre- and post-trade checks and controls on clients using algo connectivity, such as direct market access, and the increased onus on brokers to prevent algos from sending manipulative, erroneous or abusive orders.

Some brokers feel the exchange is in the best position to impose these risk controls, or filters, as a market-neutral operator that should monitor systemic risk. Brokers, in particular, feel that they are being hard-squeezed to play the role of a supervisor or scapegoat in case an algo goes wrong and causes wild swings to the market.

But brokers should still assume some responsibilities for monitoring pre-trade risk, suggests Steward, as they have a relationship with the clients and best understand their trading objectives.

He notes that since 2008 the SFC has issued 18 compliance advice letters to intermediaries after witnessing disruptive prices or stock spikes mainly caused by algos.

“[These proposed requirements] are not built on fears but on our experience of looking at these issues in the market over the past four years,” stresses Steward.

“Electronic trading and innovation is far from being demonised. [The requirements] are permissive rather than inhibitive on the condition that there are responsibilities put in place.”

He says the SFC has drafted the proposals to ensure intermediaries in Hong Kong will be “confident masters of new technology, not servants, or worse, victims”. The consultation process is due to close on September 24.

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