E-trading under the microscope

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Technology has had a tremendous impact on international financial markets, enabling vast quantities of the trades to be made in the blinking of an eye. But there are concerns that checks and balances have been abandoned in the pursuit of speed.

One of the most significant developments in the investment banking sector over the last decade has been electronic trading, specifically the emergence of algorithmic trading. This term refers to trades where factors such as timing, price and quantity are determined by complex computer programs and has facilitated what is known as high frequency trading, where computers initiate thousands of trades every second.

High frequency trading has made trading platform latency a major area for competitive differentiation amongst markets/exchanges and as a result there is constant pressure to push the limits of the technology.

The value of low latency access was highlighted this month when the US Futures Industry Association expressed support for efforts to promote transparency and fair access to the futures markets. The Commodity Futures Trading Commission has proposed that exchanges provide equal access to co-location facilities and allow third parties to provide proximity services.

Just this week IDC emphasised how high latency is a significant barrier to financial providers in a global market in a report on the financial sector in New Zealand. The report identified a number of core transactional areas that are highly sensitive to latency, which can also affect speed of web-based access to corporate intranets and databases.

However, moving trading from a face to face transaction to an electronic one means there is more scope for trades to be made, to paraphrase the old age, 'in haste and repented at leisure'. For example, last month an oil broker who bought more than seven million barrels of oil while allegedly 'drunk' was fined and banned from trading for at least five years. The Financial Services Authority fined former oil futures broker Steven Perkins for trading activity that started, without client authorisation, in the early hours of 30 June 2009 and culminated in August 2009, sending the price of Brent crude oil soaring.

What made this story even more shocking was that Perkins was a broker, not a trader, which meant that he was supposed to acting on behalf of traders rather than his own volition.

While human nature was at the heart of this problem, one software expert has suggested that the answer lies in yet more technology. He has claimed that similar occurrences in the future could be prevented through the implementation of pre-trade risk controls. The theory is that such systems could pick up on human error as well as flagging cases where fraud was potentially being perpetrated without impacting on the speed of access that is key to success in the trading community.

Among his suggestions is a low-latency 'risk firewall' utilising complex event processing, which could be benchmarked in the low microseconds. Such a system should detect errors in real time before they get as far as the exchange, taking on another task that was once the preserve of human beings.

The value of low latency access was highlighted this month when the US Futures Industry Association expressed support for efforts to promote transparency and fair access to the futures markets. The Commodity Futures Trading Commission has proposed that exchanges provide equal access to co-location facilities and allow third parties to provide proximity services.

Just this week IDC emphasised how high latency is a significant barrier to financial providers in a global market in a report on the financial sector in New Zealand. The report identified a number of core transactional areas that are highly sensitive to latency, which can also affect speed of web-based access to corporate intranets and databases.

However, moving trading from a face to face transaction to an electronic one means there is more scope for trades to be made, to paraphrase the old age, 'in haste and repented at leisure'. For example, last month an oil broker who bought more than seven million barrels of oil while allegedly 'drunk' was fined and banned from trading for at least five years. The Financial Services Authority fined former oil futures broker Steven Perkins for trading activity that started, without client authorisation, in the early hours of 30 June 2009 and culminated in August 2009, sending the price of Brent crude oil soaring.

What made this story even more shocking was that Perkins was a broker, not a trader, which meant that he was supposed to acting on behalf of traders rather than his own volition.

While human nature was at the heart of this problem, one software expert has suggested that the answer lies in yet more technology. He has claimed that similar occurrences in the future could be prevented through the implementation of pre-trade risk controls. The theory is that such systems could pick up on human error as well as flagging cases where fraud was potentially being perpetrated without impacting on the speed of access that is key to success in the trading community.

Among his suggestions is a low-latency 'risk firewall' utilising complex event processing, which could be benchmarked in the low microseconds. Such a system should detect errors in real time before they get as far as the exchange, taking on another task that was once the preserve of human beings.

Stewart Baines

I've been writing about technology for nearly 20 years, including editing industry magazines Connect and Communications International. In 2002 I co-founded Futurity Media with Anthony Plewes. My focus in Futurity Media is in emerging technologies, social media and future gazing. As a graduate of philosophy & science, I have studied futurology & foresight to the post-grad level.