On 22 April 2024, the Financial Markets Standards Board (FMSB) published its final Statement of Good Practice (SoGP)for the application of a model risk management framework to electronic trading algorithms.

The FMSB was established in 2015 in light of the recommendations of the Fair and Effective Markets Review in the UK with a mandate to issue standards designed to improve conduct and raise standards in wholesale financial markets. FMSB standards and SoGPs do not impose legal or regulatory obligations on member firms, nor do they take the place of regulation. In the event of any inconsistency, applicable law, rules, and regulation will prevail.

The purpose of the SoGP is to support firms in applying model risk management frameworks in a proportionate and tailored manner to models deployed in their electronic trading algorithms (‘Algos’). The focus of the guidance is in areas where market practitioners, including ‘first line’ risk owners and ‘second line’ risk managers, have identified that the nature of model use in Algos merits a differentiated approach compared with other model types. In particular, the SoGP considers:

  • Key factors in determining if a method used in an Algo constitutes a model.
  • Factors influencing the risk-tiering assigned to a model used in Algos, and the impact of mitigating controls in reducing the residual risk of a model.
  • Key features of model testing for Algos.
  • Tailoring model risk management activities for models deployed in Algos to the context and purpose for which models are deployed, focusing on model methodology and input accuracy, staffing and ongoing performance monitoring of outputs.
  • The treatment of material changes to models deployed in Algos from a validation and documentation perspective.

Myles McGuinness, CEO of FMSB, said: “We would like to thank our Members for this work addressing how to apply model risk management frameworks to electronic trading algorithms. It is important that the industry comes together to make sure that good practice in a complex area such as this is set out in a way that can be well understood and easily applied, including practical examples.”