Trading System Kill Switch: Panacea or Pandora's Box?
An article by New York Institute of Finance instructor John Rapa.
There has been much publicity and opinions lately about the need for exchanges, ATS and other trading platform providers to have “kill switches” that can be triggered if there are disruptions similar to the Flash Crash, Knight Capital, BATS, NASDAQ or Hash Crash problems.
Last fall, the SEC requested details from major broker-dealers about the internal controls of their automated trading systems, which direct the buying and selling of shares to exchanges and electronic-trading venues.
The Commission seeks details on "automatic shut-offs or kill switches" that would turn off trading programs when they run afoul of preset limits on risk or other parameters, and at what point people are able to step in to switch off a system. They also wanted to know about system malfunctions and how they were handled as well as how firms can override their computers and shut them off.
Regulators are trying to gain a better grasp on heavily-automated securities markets, alongside a separate review of big high-frequency trading firms and an investigation into whether some high-speed firms enjoy special advantages when dealing with stock exchanges.
Market practitioners are concerned that if an automated kill switch kicks in at the wrong time, it may have the effect of de-stabilizing the system. They are reluctant to pull the trigger and shut off their order flow from the market.
They are concerned that the timing of the decision to turn off the system may lie with understanding the nature of the underlying problem.
Many brokers want to be alerted before their orders are cut off, to be able to explain to their customers if the trading is unusual or normal.
Market participants and regulators have debated the need for multi-level kill switches, whereby an exchange or ATS would notify firms by phone calls or email before cutting off their order flow. But, this may have the effect of setting kill switch trigger points with a wider margin of error to their threshold calculations.
Others are concerned that we do not add more layers of complexity on an already complex, fragmented market structure.
With today’s high speed, smart routing of orders to the best market, how effective would a kill switch be on orders that are “routed away” or in flight?
There are pros and cons to the concept of having a kill switch, but:
How would the kill switch account for inter-product or inter-market spread orders? What is the exposure if only one leg of the order strategy was killed?
Who is liable to the customers for any resultant market action error trades?
A kill switch with one threshold based on one variable will not be viable.
The last thing people want is a well-intentioned kill switch that disrupts proper (not run away) market activity
The concept of a kill switch is a great idea, but it is inconceivable that an exchange or trading platform provider will implement a system that abdicates the total control of the market or system’s operations to an automated kill switch function.
If more trained eyeballs were looking at control screens during the above problems, humans would have intervened and common sense would have/should have prevailed.
Fast moving, fragmented markets need smart technologies as well as smart humans overseeing them.
Objective feedback is needed from senior technologists who have built and implemented large complex trading systems, as well as senior management from exchanges and trading platform providers that are responsible for trading operations.
These individuals should have experience with the vagaries and nuances of trading, as well as how to best handle disruptions “on the fly”, while maintaining fair and orderly markets.
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