The UK’s Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) have issued publications on firms using algorithmic trading and operating in wholesale markets. The FCA outlined its five key areas of focus while the PRA publication is a consultation on “expectations for the prudential aspects of risk management and governance of algorithmic trading” at PRA-regulated firms.
In its report, the FCA noted that firms operating in wholesale markets have begun increasingly using algorithms for making execution and investment decisions in trading activity. While the technology can bring efficiency benefits for investors, the FCA has also warned that the risks of automated technology requires key oversight functions. The report summarises the FCA’s key areas of focus for algorithmic trading compliance in wholesale markets:
- Defining algorithmic trading: to ensure firms have an appropriate process of identifying algorithmic trading and therefore can maintain an inventory of all algorithmic trading.
- Development and testing: to ensure firms have consistently tested trading algorithms to identify any issues before deployment.
- Risk controls: to ensure firms develop robust risk controls to mitigate any trading risks when deploying algorithms for trading activity.
- Governance and oversight: to ensure firms maintain governance frameworks to oversee risk management and compliance for algorithmic trading activity.
- Market conduct: to ensure firms consider the broader impact of algorithmic trading on market integrity and reduce the risk of market abuse.
In its consultation paper, the PRA proposes releasing a supervisory statement (Statement) to apply to all algorithmic trading activities of a firm including in respect of unregulated financial instruments. The Statement is structured in the following sections:
- Governance: the PRA proposes that a firm’s governing body explicitly approve the governance framework for algorithmic trading, including the implementation of a sound risk management strategy and framework.
- Algorithmic approval process: the PRA proposes that firms have a robust algorithm approval process with clear scope and conditions that would need to be met prior to approving use of an algorithm.
- Testing and deployment: the PRA proposes that all algorithms and risk controls be tested prior to deployment and subject to periodic re-validation to mitigate the risk of an algorithm not operating as intended.
- Inventories and documentation: the PRA proposes that firms create and maintain comprehensive inventories of algorithms and risk controls as well as documentation setting out strategy, architecture and kill-switch control procedures – to challenge and mitigate any potential risk.
- Risk Management and Other System and Controls functions: the PRA proposes that each firm’s Risk Management function and Other Systems and Controls functions understand and have oversight of the risks of algorithmic trading to impose additional risk controls when required.
Consultation closes 7 May 2018. The PRA intends to publish a Discussion Paper on operational resilience later in 2018.