WITH GLOBAL TRADING SPEEDS accelerating, pretrade risk assessment is finally getting its due. Since the “flash crash” rocked U.S. stock markets on May 6, 2010, hewing nearly 1,000 points from the Dow Jones Industrial Average in minutes, market operators have focused on designing fast, integrated risk safeguards that meet tough new regulations and keep their trading clients from losing sleep. Even the top European exchanges want to build client confidence, though the flash crash spared their trading platforms. “How do we reassure investors that they’re not going to be overrun by a rogue algorithm and lose the entire value of their holdings based on the momentum of a flash crash?” asks Antoine Shagoury, chief information officer of London Stock Exchange Group.
The LSE has courted high-speed trading firms by boosting its execution speed, providing co-location services and, as of last June, opening its order books to sponsored access. Nonmember firms can now connect to the exchange’s primary order book and those of Turquoise, its pan-European multilateral trading facility, by using a sponsor’s identification codes. Now Shagoury is eager to develop tools that help customers better manage risk and glean market intelligence. “We’re looking to marry market management and real-time risk controls to the speed of execution,” he says.
Regulators demand no less. Last July the U.S. Securities and Exchange Commission brought in the market access rule, which requires broker-dealers to establish and enforce new risk management controls and supervisory procedures for their own accounts and any sponsored access they provide to external trading firms. In December the European Securities and Markets Authority issued broadly similar but principles-based guidelines that will require European market participants to add a host of pre- and posttrade risk management controls by this May.
The new rules prescribe far-more-detailed pretrade risk analysis and real-time order surveillance across multiple asset classes and markets. The push for compliance could present “a ton of opportunity” for technology providers, says Adam Honoré, research director at Boston-based advisory firm Aite Group. European banks and broker-dealers may need to integrate new tools to manage their risk and observe their own market exposures and trading patterns.
Among the exchanges, Nasdaq OMX Group gained an early edge as a technology provider by acquiring New York-based risk-monitoring and trade aggregation specialist FTEN and Sydney-based market surveillance leader Smarts Group Holdings in 2010. NYSE Euronext’s division NYSE Technologies has developed its own multimarket risk assessment service.
With the implementation of the ESMA guidelines in Europe, banks and broker-dealers will have to reassess their pre- and posttrade risk management. Nasdaq may have the most established beachhead of all the European players, but it’s still comparatively small. Deutsche Börse’s pretrade risk analysis service, launched in 2010, only pertains to exchanges served by Eurex Clearing.
Thanks to faster trading speeds and greater intermarket connectivity, quantitative hedge funds and high frequency trading firms have begun operating more broadly in Europe, taking advantage of sponsored access. In 2008 sponsored access accounted for just 12 percent of pan-European trading volumes, according to Aite Group; by 2011 that total had reached 28 percent. Aite’s Honoré hopes ESMA’s new risk assessment requirements — including real-time, cross-market monitoring of all order flow — will spur regulators worldwide to collaborate. Otherwise, nimble trading firms will shift from transparent, well-regulated markets to more-opaque ones.
“There is no global conference call on pretrade risk, but there probably should be,” Honoré says ruefully. • •
