"In 2008, we were averaging close to 50 errors in a month and now we’re down [to] around 19 or fewer, and we really do believe that it’s very much so attributable to the automated processes that we put in place: Price banding, no-bust ranges, credit controls," says CME COO Bryan Durkin. "Each year we come up with some additional innovation, which allows us to minmize the occurrence of these situations."
Ed Dasso, manager of market regulation for Intercontinental Exchange (ICE), says ICE is looking into the adoption of stop logic, and also believes in more uniformity across platforms.
"There should be standardization," says Robert Brown, global head of eBusiness integration at BGC, "but it’s going a little bit too far to say they need to be in place for every single trader."
Steffen Kohler, head of product development at Eurex, says procedures are already standardized in the EU.
"In the U.S., you have these case-to-case laws," he says. "But in the EU, the principle is one rule has to fit everything, which is a challenge because different market participants have different interests."
The debate becomes intense when they start talking about what happens if the filters fail and an error takes place — especially if that error triggers other trades in other accounts, and those trades lose money. On particularly wild days, like May 6, trades executed outside a certain range may be "busted" (canceled), and it’s not always clear what guidelines indicate if that happens or not.
"They don’t tell you right away, either," says Shelly Brown, a director with Chicago trading firm PEAK6 Investments. "We spent some long hours on May 6 not knowing what our position was or what our risk exposure was, and we’re not alone."
The problem, he says, is not the busted trades, but the trades that remain after a bust. "If you’re a market-maker or options trader, you’re always hedged. That’s rule number one," he says. "But let’s say you have a position, and then you hedge it, and then the first trade gets busted. Now what you thought was a hedge is really a liability. That’s what we were afraid was going to happen to us on May 6."
Fortunately, that didn’t happen — at least not to him. But trades were busted, and traders say that makes them reluctant to take positions on wild days for fear of either hedging or exiting those trades and then finding themselves back in the market.
The CFTC exchange survey cited above shows that six of the 20 exchanges require those who make an error to compensate those who lose money if that error triggers contingent orders, such as stops.
Boyle says the exchanges prefer to adjust rather than bust, but that that’s not always possible. "Let’s just say this is a stock that opens at $4, but then you get this outlier price, and suddenly it’s at $1," he says. "You can’t always adjust a customer’s buy limits back up to, say, that $4 level because the customer says, ‘No I have a limit in buying it at $1, and I’m not buying them at $4.’"
Kohler agrees. "On the one hand you have market makers that need certainty and immediate certainty would be best," he says. "On the other hand, we have a number of end customers that do not have this highly sophisticated trading validation methodology and infrastructure and we have to give them the chance to get out of a trade if the price is bad."
"We adjust wherever we possibly can in the U.S.," says Lynn Martin, COO of NYSE.Liffe. "Europe is a slightly different set of considerations because the U.S. has more algorithmic traders spread across more market structures."
When busts do occur, she adds, it’s important to keep the lines of communication open and clear.
"On May 6, in the equities market, quite a few trades were busted as a result of their impact on the market," she says. "In a situation like that, the most important thing is to communicate effectively with the market about when a decision is made, how it is being made and why."
Don Wilson, CEO of hedge fund DRW, agrees — and says firms must communicate errors as soon as they discover them as well. In some cases, that’s incentivized.
"At Eurex, if you apply for a mistrade within the first 30 minutes, the trade would be busted," he says. "Then, from minute 31 to minute 180, the beneficiary of the trade has the right to make the decision to either [bust it] or adjust it."
That works in futures, but less so in equities and options where trades are executed at the best price on several exchanges simultaneously and more interlinking positions are created as a result. In those markets, the chance remains for a market-maker to be stuck with unhedged positions in the event of a busted trade. Boyle, however, says that concern shows how far the markets have actually progressed.
"It’s like the automobile," Boyle says. "When it went 10 miles per hour there was little risk of a serious injury in an accident, but that changed once you got it going 50 or 60, and safety standards needed to follow."
He says that markets have gotten faster and more efficient, so both operators and users have to become more diligent.
"Your broker better be very professional in how he’s handling himself and how he’s working," he says. "And the exchanges all need to become very good at monitoring and controlling the process. We’re like the car manufacturer and the brokers are the users."
And using the speed analogy, if the old floor with runners bringing orders into the pit was the 10 mph stage, current markets where trade latency is measured in micro-seconds has broken the sound barrier. Pilots know what happens when you make a mistake at that speed.