Risk Transparency Sets Execution Firms Against FCMs and Exchange

Posted May 17th, 2012 by The Options Insider in Trading & Analysis

One piece of good news coming out of todayís FIA Expo NY in midtown Manhattan is that most industry participants are on the same page when defining risk management.

Conference panelist and Allston Trading CTO Peter Nabicht summed it up succinctly as not adversely affecting the market while ìmaking sure we come back everyday, so donít lose the firmís money.î

Yet the FCMs and exchange would sleep better at night if they had a bit more transparency into what the executing firms are doing with their algorithmic trading strategies.

ìWe donít want enough information to reverse-engineer their strategy,î said Tayloe Draughon, e-solutons, global head of products & strategies, Newedge Group. Nor does he want FCMs to be put in place where FCMS would need to certify execution firmís trading algorithms. ìHowever, we would like to know how to react to them if something goes wrong. Fire-and-forget technology scares the hell out of me. I want stronger testing tools and to make sure the algorithms have been tested.î

Fellow panelist Tim Gits, senior vice president, head of sell-side business development Eurex concurred from the exchange perspective. ìIf we have a trader who is registered as a point-and-click trader and all of a sudden theyíre doing sub-millisecond executions, we know something is wrong and we will have discussion with them.î

The CME Group has gone as far as releasing a new black-box GUI to clearing brokers that provides a real-time drop-copy data feed, which they can be feed in to the firmís risk management system, and comes with an API to send in block and cancels.

ìOnce thatís available to trading firms, itís going to be like the release of the iPad 4,î joked Allstonís Nabicht to fellow-panelist.

Nabicht feels that that execution firms already give up enough information to FCMs, exchanges and regulators and wants to be sure that any additional data would be used before providing it. ìIf you want to go down a rabbit hole, try to find out how OATS data is being used,î he said. ìIn a recent funding request, the Commodity Futures Trading Commission asked for resources for 400 new lawyers ñ not developers ñ lawyers to understand all of the laws that have been past. To understand the volume of requested data, theyíll need developers.î

This does not mean that algorithmic trading firms are operating without a net.

ìThey are some of the most risk-adverse firms Iíve ever seen,î commented Jodi Abudarham, executive director, partner exchange & client technology management at the CME Group and who desribed the new product. commented describing past risk audits in which she participated.

ìFor any risk check someone asks us to put between ourselves and the market, it is likely to be the fifth such risk check since we already have four internal risk checks that check things,î said Nabicht.

The firm also runs regular unannounced, except to the exchange where the trades are placed, fire drills to test their operations team. ìAfter the risk system, the next line of defense is how fast your operations people can react to an event,î explained Nabicht.