From three Chicago academics, a push for HFT quality management standards

First Published 8th August 2012

In the aftermath of the Knight trading disaster, three academics have asked the X9 standards body to consider their proposal for HFT quality management standards.

Ben van Vliet, Illinois Institute of Technology

Ben van Vliet, Illinois Institute of Technology

"It's a way for the industry to say, 'We take ethics seriously, we take the quality of our systems seriously.' Because I think if the industry doesn't do that, they're going to be regulated into oblivion."

Three Chicago-based academics have proposed creating standards for quality management in the high frequency trading arena.

Work on the proposal had begun long before last week's trading disaster at Knight Capital Group, but the authors decided to go public with their ideas once news emerged of the software glitch that cost the Wall Street firm $440 million.

Ben van Vliet, assistant professor at the Illinois Institute of Technology (IIT), said the X9 financial industry standards body was considering whether to set up a committee to oversee development of the standards.

Van Vliet, along with Adjunct Professor Andrew Kumiega and Assistant Professor Rick Cooper, both of whom are also at IIT, and Jim Northey of FIX Protocol, have co-authored a paper called "The rationale for HFT 9000: An ISO 9000-style Quality Management System for High Frequency Trading".

"It's a way for the industry to say, 'We take ethics seriously, we take the quality of our systems seriously.' Because I think if the industry doesn't do that, they're going to be regulated into oblivion," van Vliet told Automated Trader.

He said he had presented the proposal to the markets regulatory staff at the Chicago Mercantile Exchange and that it has been circulated to the Commodity Futures Trading Commission and the Securities and Exchange Commission.

The paper notes that the SEC and CFTC had lowered the bar for proving market manipulation from intent to recklessness.

"So, in the case of failure of an HFT system, how can the organisation prove it was ethical, that it was prudent in its HFT research and development (R&D) and operation and control (O&C)?" the authors wrote.

The answer, they said, was that they could do so by showing they followed a recognisably prudent process that documented the firm was justified in believing in the stability of its HFT system.

"By following ISO 9000-style standards, an HFT firm can satisfy their organisational ethical obligations to prove and document that its HFT strategies and technologies will operate safely and profitably," the paper said. "There is also a wide body of literature demonstrating that the use of quality management systems increases the financial performance of the firm."

Examples of specific requirements in HFT 9000 are: that the firm has installed and verified safety controls such as "kill switches", verified acceptable algorithmic behaviour under a variety of market stress conditions, and employed proper software and system version release management.

The authors said the probability of failure can never be driven to zero due to unexpected interactions between proprietary systems, but quality management systems have been proven very successful across a number of industries.

Asked whether Knight was a factor in the decision to push forward with the proposal, van Vliet said: "Absolutely. My phone started ringing off the hook."

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