NEW YORK (Reuters) - Six months after a software glitch nearly sank Knight Capital Group, risk controls in the largely automated and lightning-fast market place are still not where they need to be, the chief executive of the Financial Industry Regulatory Authority said on Wednesday.
Major brokerage firms and exchanges have taken steps in recent months to boost supervision around technological changes in their trading systems and to limit their credit exposures to possible errors, but more needs to be done to safeguard the system, FINRA’s Richard Ketchum said in an interview.
“I would hope that we are in a much better position on that issue in the next six months,” he said.
By then, Ketchum said, brokerages with direct market access should have installed so-called “kill switches” that could stop the flow of trades into the market if an algorithm or other piece of software goes awry, as happened with Knight.
Exchanges and alternative trading systems will also need to implement a coordinated market-wide kill switch, he said.
Ketchum said brokerages were making progress on kill switches, but that there are challenges in properly designing them. “It’s still an exercise in development,” he said.
On August 1 a software issue at Knight led to millions of unintentional orders flooding into the market over a 45-minute period, leaving the firm with a huge position it had to unload at a loss of $461.1 million.
It happened just months after Facebook’s botched IPO on the Nasdaq and the failed IPO of BATS Global Markets on its own exchange.
In May 2010, the “flash crash” temporarily wiped out about $1 trillion in paper value in the stock market in a matter of minutes.
Following that event, regulators introduced circuit breakers, which halt trading for several minutes when stocks move more than 10 percent in five minutes. More recently, a one-year pilot program to pause stocks that trade outside of a range of recent prices was approved.
“We have seen a lot of changes and there are undeniably better controls” in the markets than in the past, Ketchum said.
“I am not sure we are where we need to be and I think the evolution of a fail-safe exchange-type kill switch makes sense beyond that,” he added.
Another issue that has caused investors to question the safety and fairness of the markets has been the increase of high-frequency trading, or HFT.
Ketchum said that FINRA has seen a relatively low number of instances of high-frequency traders manipulating markets, which does not suggest an unfair marketplace.
“But that is a huge focus of our market surveillance today,” he added.
He said FINRA will bring enforcement cases this year against HFT firms that manipulate stocks by sending massive amounts of orders so that favorable positions can be established in stock options, as well as firms that place large numbers of orders on existing holdings to drive up the value of a fund.
FINRA is not just looking for “pure egregious manipulation,” but also international activity without proper supervision that results in account intrusions, anti-money-laundering issues and a variety of other things, he added.
Reporting by John McCrank; Editing by Dan Grebler