By Lauren Tara LaCapra and Dan Wilchins
Aug 3 (Reuters) – Wall Street banks and brokers are poring
over their trading systems and rethinking the way they test
software to make sure they don’t become the next Knight Capital
Group, the trading firm whose survival was imperiled by
a software glitch on Wednesday.
Knight Capital’s $440 million loss from errant trades, which
has forced the company to consider selling all or part of
itself, is the third time in five months that technical bugs
have caused trouble for Wall Street players.
Executives at trading firms said they are debating among one
another whether new regulations could prevent these snafus. But
they also said glitches were a wake-up call for firms to improve
their controls on their own, without being pushed into it. At a
time when Wall Street is cutting costs, spending money on better
systems to test software and manage risk could be an expensive
proposition.
“We want to make sure that what happened to Knight doesn’t
happen to us,” said the head of one investment bank. His company
was looking carefully at how it tests new trading systems, to
make sure traders know when new systems are being implemented
and can be on the lookout for suspicious activity during those
periods.
Their efforts face plenty of obstacles. As more trading has
m oved from exchange floors to computers over the last decade,
the speed of execution jumped along with the potential for
cascading problems.
T rading firms, market makers, brokers, investment banks , and
exchanges and other trading venues are linked in a n etwork o f
co mplex co mputer systems that co mpete to execute trades as fast
as possible. That competition, combined with the never-ending
array of new rules, forces ma r ket participants to constantly
improve their systems.
But the intricate network of players and systems creates a
m uch wider range of potential problems for trading systems,
making te sting c ostly and difficult. Good testing requires a
firm to imagine everything that can possibly go wrong and how
the system will interact with other systems. Predicting every
plausible scenario is not easy, said one trading head at a major
Wall Street firm.
Regulators have set up “circuit breakers” that require
exchanges t o suspend trading in stocks that move too much too
q uickly. B ut dealers and other market players usually have even
more sophisticated circuit breakers for their own trading.
” You need an algorithm to monitor the trading algorithm, “
said John Bates, c hief technology officer at Progress Software,
which provides trading software.
Knight appeared to lack these sorts of circuit breakers, or
at least did not implement them well enough, traders said.
Two other major trading glitches have beset Wall Street
since March. BATS Global Markets, an exchange, was
unable to complete its own initial public offering because of a
technical problem. Nasdaq botched the market debut of
Facebook due to systems bugs, costing it tens of millions
of dollars, while UBS AG lost more than $350 million
in trading Facebook shares and is blaming Nasdaq.
LOWER VOLUMES, HIGHER PRESSURE
Dealers don’t always do a great job of testing, said Colin
Clark, a developer with Cloud Event Processing, a firm that
works with big Wall Street banks and exchanges on software and
technology.
“They’re not investing enough in testing now,” Clark said,
noting the pressure banks face to cut costs.
U.S. stock trading volume is 40 percent below its peak
volume in 2009, according to Tabb Group, falling from an average
of 12 billion trades a day to 6 million to 7 million currently.
That decline has weighed on profits at firms, and strained the
willingness of many to invest in unglamorous areas like testing
systems, said Larry Tabb, founder of Tabb Group, a consulting
firm that focuses on capital markets.
“There are fewer people minding the store, and the people in
place are stretched too thin,” Tabb said.
But others on Wall Street dismissed the notion that dealers
are not investing enough in their systems, noting that dealers
spend millions on technology in part to be more efficient and
reduce staffing levels.
In addition to testing new systems, firms are checking their
mechanisms to protect them from bad trades. Most dealers have
systems that automatically stop trading, or at least generate
warnings for traders, when volumes or price movements are
suspicious.
Dealers can try to improve their own systems, but it is
possible that new rules could prevent breakdowns as well. One
idea that dealers have discussed in the wake of the Knight
Capital mess is eliminating “market orders,” or orders that are
executed at whatever the prevailing market price is. Retail
investors often place market orders.
Customers could instead be required to place “limit orders”
that specify the maximum price at which they will buy a stock,
for example. With limit orders, if the market price of a stock
surges because of technical glitches, many orders to buy shares
would not be executed.
Another idea dealers have discussed is to slow down trading,
to ensure that they have a handle on what they are doing at all
times.
“If so many trades are happening in a millisecond, it’s hard
to keep up with everything you’re doing,” said one of the senior
Wall Street traders.
