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FCA CEO Andrew Bailey said: “It’s very important to focus on how algos are used. It’s one thing having a badly programmed algo. I think from experience a bigger issue is the inappropriate use of algos.
“Using in an algo in market conditions when you shouldn’t, when the market is too thin and you need to exercise human judgment — that’s one example.”
“Algos” is the term given to computer programmes carrying out trades in the market for customers. These programmes can be set to do all sorts of things, from purchasing or selling a certain stock once a given price is reached to gradually selling down a holding to ensure that you get the best price.
Algos became widely known due to author Michael Lewis, who wrote The Big Short, in his book “Flash Boys.” The book touches upon high frequency traders utilising algos to complete trades in milliseconds, and was harshly critical of how algos are applied.
Algos have also gained bad reputation for the wrong reasons straight after the pound was struck by a so-called “flash crash.”
Earlier this month, the pound face a step downfall of 6% in 2 minutes and algos were said to be blamed by market participants.
The pound broke through a particular level, causing some algorithms to automatically sell.
Bailey did not directly point finger at the flash crash but that is what his comments on volume seem to be implying. Bailey also emphasised on the Swiss franc being de-pegged from the euro. This decision made by the Swiss central bank resulted in the Euro nose diving almost 30% against the Swiss franc.
He said: “Go back to the Swiss franc de-peg for example. One of the big lessons out of that was how to firms react when that sort of thing happens? Sometimes you go into firms and they say we pull the plugs out at that point — I think that’s a metaphor. You go, well that’s great, but what do you do next in terms of the management of your positions and the management of your algos?
“When we were doing the planning for the UK referendum we spent a lot of time on this question. Had we had a big gapping (big price moves without trading) markets, we were very sensitised to: do firms understand their trading controls properly?”
The FCA’s director of supervision Meghan Butler added: “We do not investigate the individual operation of each algo or approve it or anything of the sort. I’m not aware of any regulator that does do that. It’s an interesting point to raise, it’s a live conversation among regulators at the moment.
“Our approach on those is to recognise that a poorly designed, poorly controlled, inappropriately used algo can have a very significant negative impact on the proper operation of the market. Our intention in that area…. is we seek to ensure that the organisations that design them and use them, and indeed sometimes sell them on to third parties, do so in an appropriately controlled manner, so that they understand it and can control it.”