The FCA has published a report on algorithmic trading compliance in wholesale markets. The report summarises the regulator’s key areas of focus and highlights examples of good and poor practice.
The report notes that firms should reference a number of pieces of legislation when developing algorithmic trading practices and procedures most notably MiFID II. In the UK, the algorithmic trading requirements were introduced through chapter 7A of the Market Conduct Sourcebook (MAR). Further specification is provided in the MiFID II Commission Delegated Regulation 2017/589 of 19 July 2016 (also known as RTS 6).
The report highlights the key requirements in MiFID II relating to algorithmic trading and identifies five key areas of focus:
- Defining algorithmic trading (page 8 of the report): Firms must establish an appropriate process to identify algorithmic trading, manage ‘material changes’ and maintain a comprehensive inventory of algorithmic trading across the business;
- Development and testing (page 11 of the report): Firms must maintain robust, consistent and well understood development and testing processes which identify potential issues across trading algorithms prior to full deployment;
- Risk controls (page 16 of the report): Firms must develop suitable and robust pre and post trade controls to monitor, identify and reduce potential trading risk across algorithmic trading activity;
- Governance and oversight (page 19 of the report): Firms must maintain an appropriate governance and oversight framework which demonstrates effective challenge from senior management, risk management and compliance on algorithmic trading activities; and
- Market conduct (page 23 of the report): Firms must appropriately consider the potential impact of their algorithmic trading on market integrity, monitor for potential conduct issues and reduce market abuse risks.
Key messages from the FCA include:
- in general, the FCA has been encouraged that firms have taken steps to reduce risks inherent to algorithmic trading. However, further improvement is needed in a number of areas. For example, the regulator has found that some firms lacked a suitable process to identify algorithmic trading across their business and did not have appropriate documentation in place to demonstrate suitable development and testing procedures are maintained. In these cases, firms also lacked a robust and comprehensive governance framework;
- firms need to do more work to identify and reduce potential conduct risks created by their algorithmic trading strategies. This includes delivering suitable market abuse training for staff involved in the development and implementation processes. Firms also need to consider the potential impact their algorithmic trading activity may have on the fair and effective operation of financial markets; and
- the FCA will continue to assess whether firms have taken sufficient steps to reduce risks arising from algorithmic trading. These will include MiFID II investment firms and those non-MiFID investment firms, such as collective investment firms engaging in algorithmic trading, who are subject to the relevant requirements under Article 17 of MiFID II.
View FCA publishes report on the supervision of algorithmic trading, 12 February 2018