Regulators Eye Algorithms

Terry Flanagan

With regulators signaling greater oversight of algorithmic trading strategies, the issues of software development and quality assurance testing have come to the forefront.

To that end, companies that develop algorithms either for their own use or for others would need to deploy more rigorous controls over product development and testing.

“As markets change or as client interest changes, we will basically decide whether we want to re-evaluate an algorithm,” said Jeff Bacidore, head of algorithmic trading at Investment Technology Group. “Once we do that, we engage our research team, so it often involves a lot of data analysis, or just thinking about some theoretical analysis of how we want to approach the problem differently.”

After the R&D phase, it’s time to engage the developers, who are the ones that actually write the code. The algorithm then goes through ‘alpha’ and ‘beta’ testing to make sure it works as advertised.

“We roll it out to beta to get a sample flow, and once we’re comfortable that it actually works and doing exactly what we want, then we’ll start rolling out to clients,” said Bacidore. “As we do that we get their feedback, make sure it’s doing what we said it’s going to do, and what they want it to do.”

ITG recently launched a dark aggregation algorithm, Posit Marketplace 3.0, which is designed to increase fill rates in non-displayed venues while filtering out potentially toxic liquidity.

In the U.S., the Financial Industry Regulatory Authority last month issued a proposal to establish a registration requirement for persons who are primarily responsible for the design, development or for directing the significant modification of an algorithmic strategy, or responsible for supervising such functions.

Finra will publish guidance reminding firms of their existing supervisory obligations with regard to the development and deployment of algorithmic trading strategies.

“We’ll also provide additional guidance to firms on effective controls and practices to monitor for and prevent potential adverse impacts on the market,” Carlo di Florio, Finra’s chief risk officer and head of strategy, in an Oct. 20 speech. “The guidance will also cover firms’ obligations in these areas, and supervision and control practices for firms and market participants that use algorithmic trading strategies.”

Featured image via iStock

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