Firms need to do a better job of managing the risks that arise amid the widespread use of algorithmic trading, which can have outsize an impact on markets and the financial system overall, says a report published Monday by the U.K. Financial Conduct Authority (FCA).
The report, Algorithmic Trading Compliance in Wholesale Markets, calls on firms to do more to ensure that they are properly managing the sorts of risks that can be amplified by automated trading.
According to the report, the FCA recently reviewed firms’ supervisory efforts and found that firms have taken steps to reduce the inherent risks of algorithmic trading, but that further improvement is needed in a number of areas.
“In the absence of appropriate systems and controls, the increased speed and complexity of financial markets can turn otherwise manageable errors into extreme events with potentially wide-spread implications,” the FCA report says. “As a result, algorithmic trading continues to be an area of focus for the FCA and other regulators across the globe.”
In particular, firms need to do more to identify and reduce potential conduct risks created by their algorithmic trading strategies.
“Firms also need to consider the potential impact their algorithmic trading activity (including the combined impact of multiple algorithmic strategies) may have on the fair and effective operation of financial markets,” the report says.
Additionally, the FCA found that some firms don’t have adequate processes in place to identify algorithmic trading across their businesses, and don’t have documentation to show that they have suitable development and testing procedures. These firms “also lacked a robust and comprehensive governance framework,” the report says.
The report also highlights good and bad practices that it uncovered in the course of its firm reviews.
‘This report is relevant for all firms developing and using algorithmic trading strategies in wholesale markets. Firms should consider and act on its content in the context of good practice for their business,” says Megan Butler, director of supervision, investment, wholesale and specialist, FCA, in a statement.
Also Monday, the U.K. Prudential Regulation Authority (PRA) also published a consultation paper on proposed expectations regarding a firm’s governance and risk management of algorithmic trading, which sets out expectations for the prudential aspects of risk management and governance of algorithmic trading.