What is the AT firm’s organizational responsibility?

The SEC and the CFTC have recently lowered the bar for proving market manipulation from intent to recklessness, implying (in the case of AT, necessarily organizational) imprudence or irresponsibility.  So, in the case of failure of an AT system, how can the organization prove it was responsible, that it was prudent in its AT research and development (R&D) and operation and control (O&C)?  The answer is they were responsible because they followed a recognizably prudent process, one that proved and documented that the firm was justified in believing the future performance (i.e. stability) of its AT system.

AT systems make decisions based on proven research.  As such these systems can only modify the outcomes of these decisions using the structures embedded in the software (i.e. real-time risk control).

How do you know your trading system will work?  What passes as proven research?  The obligation of the AT firm is to prove and document that an AT system’s trading strategy and technology will operate in line with expectations and to specification.  Prudence demands that the firm prove that its systems will run in control.  This obligation can be satisfied by following a prudent process that justifies expectations in the performance of the AT system.

What are the responsibilities of AT firms?

People involved in AT now have both internal responsibilities to their firm and its profitability and external responsibilities to ensure the safe operation of their systems.  What’s problematic is that there are many different, and often competing, views on what the responsibilities are or should be in AT.

AT is an interdisciplinary endeavor requiring the input of traders, computer engineers, and quants.  Each of these disciplines has its own perspective. Traders, for example, often take seriously their principal function and obligation to maintain orderly markets.  Computer engineers have their own codes which require avoidance of unsafe practices and fail-safe design.  (These concepts are most often embedded within the topic of software quality.)  Responsibilities in quantitative analysis revolve around staying within the strategic bounds defined in exchange rules and government regulation and, furthermore, are largely thought to be superseded by adherence to mathematical truth.

Additional perspectives are added to the AT sphere by people and organizations outside the AT firm as well.  The exchanges have their perspectives, and certainly, as do people in different parts of the world.  The following figure shows the perspectives involved in AT:

These perspectives may sometimes be in conflict with each other.  Thus, different AT firms may recognize different responsibilities based upon the internal political dominance of one profession.  No framework exists in AT that considers cross-disciplinary responsibilities of safety to those who might be harmed—external market participants and society.  The new discussion needs to focus on organizational responsibilities.  Likewise, as the global trading network spans multiple AT firms, exchanges and countries, it is important also to consider the industry-wide obligations to create confidence in financial markets and their sustainability. The profitability of any individual firm cannot be more important than the safety of the global trading mechanism.

What are examples of conflicts in AT development and operation?

The need for low latency gives rise to a conflict between speed (necessary for profitability) and the inclusion of fail-safe code that may add latency (necessary for safety of external stakeholders).  An inherent conflict also exists between minimizing costs and satisfying obligations to, for example, paying for research and development of real-time risk controls and/or redundant systems.  As time to market for an AT system matters, production pressure also lead to launch of risky trading systems.  The need for profitable AT systems cannot take precedence over the quality—stability and reliability—of the global system.

What risks do AT systems pose?

Each AT system is a piece, a proprietary technological component, of the global trading network. The performance of such components affects potentially all markets, either directly or indirectly.  An out-of-control AT system can flood a market or markets with order requests on a time-scale that precludes human intervention.  Such flooding can affect market prices, the profitability of other trading firms and exchanges, as well as societal confidence in the sustainability and safety of the financial markets.  The strategic or technological failure of an AT system could be catastrophic for these stakeholders in the global trading network.

What is Automated Trading?

The definition of automated trading (AT) is much discussed.  For the purposes of AT 9000, the defining characteristic of an AT system is neither the duration of its trades nor the volume of its order requests routed to the exchange, but rather the risks a given system poses to the marketplace. Any automated or algorithmic trading system that enters computer-generated order requests into the market gives rise to immediate risks in the event of its strategic or technological failure.  Such systems, broadly defined, may engage in market making, index arbitrage, statistical arbitrage, or any number of other strategies that provide liquidity by way of automated decision-making. This definition also intends to include automated systems that take liquidity as well.