The Futures Industry Association (FIA) recently published a paper putting forward the best practices for automated trading risk controls and system safeguards. Based on a review of risk controls done earlier this year, the report covers pre-trade controls, exchange provided volatility control mechanisms, and – most of note to this publication – a post-trade analysis.
“A combination of post-trade controls, monitoring, and data collection should be used in conjunction with pre-trade controls to watch for potential credit events or unintended trading,” writes the report. It mentions three post-trade controls – drop copy reconciliation, post-trade credit controls, and exchange error trade policies.
Drop copy reconciliation
Drop copies are a type of report that “details a participant’s execution activity on a trading venue and is generated as close to real-time as possible”. FIA recommends that they “be available for all trading venues and products whenever technologically practicable”, and that “exchanges should seek consistency in the format of drop-copy reports to assist in consolidation”. In addition, “a frequent reconciliation process where the firm balances its trading systems to drop copy or clearing information can serve as an early warning for potential problems”.
Post-trade credit controls
Post-trade credit controls are “a key feature of how a broker manages its exposure to its customers through the different types of market activity in which they participate,” writes FIA. It recommends that brokers “establish post-trade credit limits that are appropriate for the market participant’s capital base, clearing arrangements, trading style, experience and risk tolerance”, based on an assessment of the customer’s assets and history. The credit limits “should be monitored across the customer’s entire portfolio”.
Exchange error trade policies
Exchange error trade policies are a form of recourse when trades occur at erroneous price levels. These error trade policies “should be designed to balance market participants’ need for trade certainty with the adverse effects of trades being executed at prices inconsistent with prevailing market conditions”. FIA reminds readers that “the goal of any error trade policy should be to promote a marketplace where all trades stand as executed”. If this cannot be achieved, a price adjustment should always be preferred over cancellation, as it’s less disruptive to impacted market participants.
