Buy-side traders in Hong Kong say planned new rules on the use of electronic trading systems and algorithms are impractical and over-burdensome and would lead firms to outsource certain risk controls and monitoring functions to brokers.
Some fund managers have argued they should not be as heavily regulated as brokers with regard to e-trading, saying they present less risk to financial markets because their executing brokers are already subject to a slew of pre-trade control and post-trade monitoring obligations.
But the Securities and Futures Commission (SFC) says asset managers should be subject to the same rules as they, too, are users of e-trading and algos. It demands the same due diligence in compliance with the amended code of conduct for SFC licensed or registered persons.
A head trader at one asset management firm says his team does not have resources to assess the performance of algos and e-trading systems provided by brokers. The SFC proposes that fund managers ensure any modifications to algos are adequately tested before they are used in the market.
“This means fund managers must perform an entire audit on a continual basis,” says the trader. “The fact is that brokers always upgrade their systems, tinkering with the rules according to the way that algo moves with one stock or another. It would take five extremely smart guys to be monitoring algos from just one broker.”
He argues that fund managers are using the tool of a licensed broker, which is a member of the Hong Kong stock exchange; if the bourse does not deem that broker qualified, it should withhold its licence.
He believes the onus of preventing an algo from performing against expectations should lie with the exchange. “The SFC should have an agreement with the Hong Kong stock exchange on a circuit breaker that the exchange would consider appropriate to capture what they both consider as excessive movement of a stock within an agreed time-frame.”
His views echo those of many brokers and proprietary trading firms, which have long argued that burdening intermediaries with responsibility for risk control and monitoring of algos – and for electronic connectivity such as direct market access (DMA) – will only create more problems for the market by disrupting a level playing field.
“The truth is that we will continue to rely on brokers for vetting algos, effectively outsourcing some of the responsibilities, as brokers are supposed to stand by the integrity of their algos,” says the unnamed trader.
But some on the buy-side are less concerned. Mathias Piardon, founding partner of managed futures investor NoHo Capital Management, says the regulator is simply formalising what many asset managers do already.
The most important thing for institutional investors in managing the risk of algorithms and DMA is to ensure that they have a proper understanding of how the algo works during abnormal market conditions, he says. “What you want to avoid is seeing the algo starting to trade in all different directions during a market anomaly as that will increase market volatility.”
Still, Piardon agrees that performing thorough due diligence on e-trading systems provided by third parties involves a lot of work and resources.