In the short span of a few minutes during the morning trading session on August 16th, an ill-fated stream of orders sent by the Chinese brokerage Everbright Securities caused the benchmark Shanghai Composite Index to shoot up almost six percent. Serious consequences ensued.
Everbright received a hefty 523 million yuan (US $85 million) fine doled out by the China Securities Regulatory Commission (CSRC), as well as life bans for Everbrights four senior executives, a three-month ban for the company from proprietary trading excluding fixed income, and suspended approval for new Everbright services. Most importantly, the CSRC charged Everbright for poor oversight of their algorithms and with committing insider trading by knowingly selling related ETFs and index futures before telling the market they had made erroneous trades.
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There is a lot to consider on why this happened from a regulatory, operational and ethical standpoint. Moreover, though its impossible to guarantee lessons have been learned from this incident (no firm is perfect, however the tools and processes already exist in the marketplace to prevent and mitigate these actions from happening), it certainly should give call to action to Chinas financial industry to take the necessary steps to safeguard against such a crisis.
We recommend the following actions:
Address pre-trade risk controls. Firms need to have sufficient pre-trade risk controls and checks in place to monitor and prevent algorithmic errors as well as regular post-trade monitoring, to identify and potentially prevent market manipulation and insider trading. In the Everbright case, these simple checks would have given them the ability to restrict certain orders from going out to market based on looking at the recent price range of the traded security. Considering the net position of the trading account would also determine if the order is within a reasonable price range and the account is maintaining a realistic overall position.
Improving trade monitoring capabilities.For years, brokers have been able to use market surveillance technology to monitor trading across global trading venues for multiple forms of cross-market abuse; however, availability of this technology has not translated into widespread adoption, particularly in Asia. Firms must be aware of the relationship between different security types on different venues, and to visualize and interrogate trading interaction between these securities to form a clear picture of their trading activity. Had Everbright used such monitoring in real time, the abusive short-selling of ETFs and index futures would have been picked up as potential insider trading and once identified, potentially prevented from continuing.
Centralize the view of trade activity. Most firms have disparate and decentralized trading platforms, making risk and surveillance oversight even more difficult. However, technology exists today to aggregate and centralize risk and surveillance across multiple trading platforms. It is essential to have a centralized view and control point, especially for pre-trade and real time post-trade risk management, in order to make sensible and accurate decisions on which orders can go to market and which should be prevented.Further, it is essential to have a consolidated view of trading activity for market surveillance purposes, to identify market manipulation and insider trading across multiple related instruments and markets.
Improve harmonization between market participants and exchanges. We recommend a pre-trade risk model where brokers and exchanges together implement safeguards that work in harmony to protect the market. By implementing a layer of simple pre-trade risk checks at the exchange, the order book can be protected from fat finger trades and price and volatility swings. This has the benefit of creating a level playing field and discouraging brokers to compete in the race to zero latency for these simple pre-trade checks. In addition, brokers should be expected to run an additional layer of pre-trade risk checks beyond the scope of those at the exchange level, specifically at the account level where the broker gets more visibility into granular account data than the exchange sees. With market participants and exchanges working in harmony we have a much better chance of truly protecting the market.
Obviously with an increase in trading complexity, there is a necessity for better risk and surveillance controls, and we can expect further regulatory pressure from the CSRC and other regulators in the region. However, firms proactively taking these necessary precautions and implementing risk controls will enforce a stronger unity with their regulator and exchange partners, as well underscore their dedication to getting in front of a potential issue that may have wide-spread impact thats suddenly beyond their control.
Michael Karbouris is head of business development of NASDAQ OMX broker technology business in Asia andUlf Carlssonis head of North Asia and Japan, NASDAQ OMX.
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to Traderseditorial@sourcemedia.com
