Best Practices in Pre-trade Risk Controls 2014


Conducting Risk Control Assessments of Electronic Execution Systems

GreySpark Partners presents a report examining best practices in the creation and implementation of electronic trading pre-trade risk controls for sellside automated trade execution systems. The report explores the implications of dramatic increases in the complexity of these sellside e-trading systems and corresponding exchange order matching platforms since 2005.

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Increases in the complexity of electronic execution systems pose risks to the orderly functioning of banks and the capital markets they participate in, both on a proprietary basis and on behalf of their clients. GreySpark believes these risks can be mitigated by a set of pre-trade risk control ‘best practices’ that can be utilised by Tier I and Tier II sellside institutions. This report presents a checklist-like set of controls that can be tailored to the specific requirements of different types of sellside institutions.

These best practices include guidelines on managing pre-trade risks associated with both sellside capital markets agency flow businesses and principal flow businesses, reviewing how risk limits should be implemented in multiple independent pre-trade components utilised by both types of model. More broadly, the report also explores sellside pre-trade risk industry best practices, explaining how these controls can be applied to trade flow risks within a bank. For example, the report looks at ideal configurations for inbound and outbound risk firewalls as well as how to set-up algorithm monitoring protocols.

In providing banks with detailed guidelines on how to implement a range of protective barriers around their e-trading systems, the report shows that unforeseen problems with the controls can be effectively risk-profiled. The report also clarifies how current limits on pre-trade risk management can be modified so that new rules can be applied while being controlled by client compliance mandates.

Additionally, this report explores historical examples of mishaps related to malfunctioning or poorly-designed e-trading systems as well as in the marketplaces that favour automated trading. The report documents the dangers of automated trading using analysis of specific historical examples and regulatory responses to these types of dangers across a number of different global jurisdictions.

The pre-trade risk controls explored in this report can be used by banks and their clients to create a universal set of best practices to mitigate potential risks on the path toward electronic trade execution. GreySpark believes the majority of Tier I and Tier II banks with robust capital markets businesses can readily adapt these pre-trade risk controls onto their existing electronic execution infrastructure.

Published on: 8 Aug, 2014

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Best Practices in Pre-trade Risk Controls 2014 – Table of Contents

  • 1.0 The Dangers of Automated Trading
    • 1.1. Automation Encompasses an Expanding Range of Trading
    • 1.2. The Changing Role of the Sellside Trader
    • 1.3. What Happens When Unmonitored Systems Fail
  • 2.0 Regulatory Responses to Automated Trading Risks
    • 2.1. Ensuring the Safety of Automated Order-processing Systems
  • 3.0 Managing Pre-trade Risk: Minimum Requirements and Industry Best Practices
    • 3.1. Managing Agency Flow Risks
    • 3.2. Managing Principal Flow Risks
    • 3.3. Industry Best Practice
    • 3.4. The Current Limits of Pre-trade Risk Management
  • 4.0 Conclusions