You know if you have an ATS and you have tested it, right? Because you are required to.

12/4/2018

ICE US just fined a company $37.5K for having an ATS that violated Rule 4.02 and required them to cease violating Rule 4.02 and also Rule 401. What is an ATS? It is any system that can enter or cancel an order on an exchange without human intervention based on programmed logic. What is rule 402 you ask? It is the disruptive trading practices section. The Rule 401 violation came because of the wording of 4.01:
"Every Person shall diligently supervise the Exchange-related activities of such Person's employees and agents. For purposes of this Rule, the term “agent” includes any Exchange-related activities associated with automated trading systems that generate, submit and/or cancel messages without human intervention. Every Person shall also be responsible for the acts and omissions of such employees and agents." (my emphasis).
Therefore, if a trader builds a model that automatically triggers trade orders, there is strict liability for supervision of the algorithm's logic. This means that you have an obligation to test the logic of your algorithms to make sure they don't violate disruptive trading rules. For example, if you have an algo that has logic cancelling bids anytime the market offer gets within a certain value of that bid or when the bid stack between that bid and the market bid, you may have an issue with potential disruptive trading - read spoofing.
DCM staff have observed that major firms have adopted an internal compliance structure for annual review of all automated trading systems -have you done something like that?

2 Comments

Dr Mark Earthey link

12/5/2018 02:32:03 am

Is an ATS review once per year sufficient? Many ATSs now incorporate an AI (machine learning) component, meaning that the trading logic itself evolves over time. So an algo that may not cancel orders and break rules 401 and 402 could well 'learn' to do so in the future. This isn't science fiction - we work in this area and know what is being planned! (energy & commodities).

Thomas Lord link

12/5/2018 07:15:15 am

Mark:

I agree with you that for more advanced shops the need to have a more proactive review may be necessary. However, many of our clients are not to the stage of having true AI built in. In these cases, a pre-review of any new strategy and an annual review to assure no changes have occurred may be adequate.

In addition, a robust trade surveillance system would be appropriate for any trading operation running true AI. The trade surveillance program, if appropriately designed and implemented, should also detect when the AI begins to exhibit inappropriate trading patterns.

It may be that very frequent code review of AI driven ATS may be more effective than trade surveillance but it could also be that the cost of high frequency review would exceed the marginal cost of assuring robust trade surveillance coverage - something a firm running AI driven ATS should have anyway.

We work to help clients with those process decisions and the strategy of optimizing their compliance dollars.

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