Direct Edge Adds ‘Kill Switches’ Inside Exchange Software

Direct Edge said it has built in pre-trade risk controls, including automated and manual kill switches, into the software that matches orders on its EDGA and EDGX exchanges.

The kill switches and other controls are being provided at no cost to brokers that are members of its two exchanges, according to head of sales Bryan Christian.

The controls, which come in response to the Securities and Exchange Commission’s Market Access rule that requires all orders sent electronically to the nation’s exchanges to be filtered through risk checks by brokers, do not slow down the speed of achieving matches even by a microsecond, he said. That’s because the checks are performed “at the exchange level” as part of all the software that all orders must pass through to achieve a match.

“There is definitely a demand for these kinds of pre-trade risk controls from an exchange level,’’ he said.

Direct Edge’s free controls went into operation Friday. Last week, BATS Global Markets also rolled out a suite of no-cost risk management tools to all U.S. equities and equity option markets customers. BATS also operates two national exchanges.

Those controls included user-set restrictions on the size or value of orders, as well as a member-controlled “kill switch.’’

In the Direct Edge case, brokers and brokers who sponsor customers that connect directly to exchanges, electronically, get a portal on their computers, through which they place restrictions and establish parameters for the orders they or their sponsored clients will send in to the EDGA or EDGX exchanges.

But it is Direct Edge’s software, near its matching engines, that will enforce the checks and validate the orders. If parameters are exceeded, the automatic kill switch will act, Christian said. But brokers using the tools also will have an on-screen icon that will act as a manual “kill” button as well.

The tools will allow brokers to block or restrict the use of specific order types, such as short sale orders; control the value or size of orders; limit the prices paid; triction of specific order types (Short Sale, etc.); restrict the stocks in which trading can take place; and create ‘aggregate’ controls on the credit risk that will be allowed.

NYSE Euronext, Nasdaq OMX Group, BATS and Direct Edge first said they were willing to set up exchange-level kill switches in September. That came out of an industry working group set up in the wake of the near-destruction of Knight Capital Group, after the market maker sent out a flood of erroneous orders that cost it $457.6 million in under 45 minutes.

The proposal came in advance of a Securities and Exchange Commission roundtable on market stability, called to deal with the Knight event and other technical disruptions of the nation’s markets this year.

The working group included Bank of America Merrill Lynch, Citadel, Citigroup Global Markets, Deutsche Bank Securities, GETCO, Goldman, Sachs & Co., IMC Chicago, ITG, Jane Street, Morgan Securities, RBC Capital Markets, RGM Advisors, Two Sigma Securities, UBS Securities, Virtu Financial and Wells Fargo Securities.

Brokerage executives have expressed concern about ‘kill switch’ mechanisms coming from the stock exchanges that might not give them enough time to react to changing market consitions..

“We worry about automation kicking in at the wrong time and perhaps destabilizing the system,” TD Ameritrade chief technology officer Lou Steinberg warned participants at the SEC’s roundtable.

But Christian points out that, in the Direct Edge case, it is the brokers who set the parameters on the kill switches, not the exchange.

“Kill switches need to be part of multiple layers,” of protections, Nasdaq OMX Group chief information officer Anna Ewing also said at the roundtable. “We need to ensure we don’t think of it as the Big Red Easy Button. It’s layered. It’s complex.’