The Financial Conduct Authority (FCA) has highlighted a number of concerns about the compliance and risk standards of firms employing algorithmic trading techniques.
In a report entitled Algorithmic Trading Compliance in Wholesale Markets, published on Monday (12 February), the regulator said the complex nature of algorithmic trading means poor oversight could turn "manageable errors into extreme events with potentially wide-spread implications".
The FCA said recent cross-firm reviews of principal traders, investment banks and investment managers had found "further improvement is needed in a number of areas".
Specifically, 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".
These firms were also found to lack a robust and comprehensive governance framework, and the FCA said they "need to do more work to identify and reduce potential conduct risks created by their algorithmic trading strategies".
It added: "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 (including the combined impact of multiple algorithmic strategies) may have on the fair and effective operation of financial markets."
The FCA's warning comes on the back of concerns that algorithmic trading techniques may have contributed to and exacerbated the equity sell-off in early February. A number of complex short volatility trading instruments witnessed heavy losses and added to the market chaos as they attempted to cover their short exposure.
Going forward, the FCA will continue to assess whether firms have taken sufficient steps to reduce risks arising from algorithmic trading.
It said: "Automated technology brings significant benefits to investors, including increased execution speed and reduced costs.
"However, it can also amplify certain risks. It is essential that key oversight functions, including compliance and risk management, keep pace with technological advancements.
"In the absence of appropriate systems and controls, the increased speed and complexity of financial markets can turn otherwise manageable errors into extreme events with potentially wide-spread implications.
"As a result, algorithmic trading continues to be an area of focus for the FCA and other regulators across the globe."
Click here to read the report in full.
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