Standards Emerge for Automated Trading

Terry Flanagan

The advent of automated trading in derivatives is throwing a spotlight on standardized risk controls, which are common in equities trading but hitherto have not been applied to the OTC world.

FIX Trading Community, in a letter to the Commodity Futures Trading Commission, noted that its Risk Management Working Group has developed and published a set of Best Practices in Electronic Trading to help firms more effectively manage risk in an environment where trading strategies are becoming increasingly complex, and to prevent a situation where the parties to a trade, or the wider market, could be adversely impacted by flawed electronic orders.

“It is important that the U.S. derivatives markets serve as effective centers of price discovery and risk mitigation as the automated trading environments continue to evolve,” said Courtney Doyle McGuinn, operations director at FIX Trading Community, in the letter, which was sent in response to the CFTC’s Concept Relapse on Risk Controls and System Safeguards for Automated Trading.

The importance of standards is recognized in the Concept Release in that the term “standards” is sued 41 times, McGuinn noted. FIX is utilized by designated contract markets (DCMs), derivatives clearing organizations (DCOs), swap execution facilities (SEFs), futures commission merchants (FCMs), swap dealers and major swap participants.

The Concept Release recognizes that orders and trades pass through multiple stages from order generation to execution to clearing and allocation in proprietary or customer accounts. The FIX Protocol codifies business processes, definitions, and message formats for the complete order lifecycle, excluding cash market settlement and payments.

FIX Trading Community’s Risk Management Working Group developed had published best practices in electronic trading for institutional market participants. It was created for equities but expanded to include futures in 2012.

“The automation of complex electronic trading strategies in a volatile marketplace demands a rational set of standardized pre-trade and intra-day risk controls to protect the interests of the buy side client, the broker and the integrity of the market,” McGuinn said.

It’s becoming increasingly common for futures and equities exchanges to provide sophisticated risk management tolls and allow an FCM the granularity to set checks for each client that accesses the exchange directly, McGuinn noted. Such tools allow FCMs to facilitate direct access without having to impose their own or third-party risk management tools between the client and the exchange.

Geneva Trading, a principal trading firm based in Chicago which trades electronically on exchanges throughout the worked, said in a letter that coherent, principle-based controls and safeguards for automated trading are critical to transparent, liquid markets and efficient price discovery.

“Geneva Trading strongly supports and agrees with the comprehensive response to the Concept Release submitted by the Futures Industry Association on December 11,” said Robert Creamer, president and CEO at Geneva trading. “We believe the FIA’s response provides a rational, data and fact-driven roadmap for best practices regarding market infrastructure, risk control and automated trading system safeguards.”

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