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BIS report on sterling flash crash highlights option hedging and stop loss orders

First Published 13th January 2017

Rogue algorithms and fat fingers not to blame.

The Bank for International Settlements (BIS) today released its report on the sterling flash crash of 07 October 2016 when GBP/USD fell as much as 8.1% in just one minute.

The bank concluded that a "confluence of factors" were responsible for the decline. These included, "options-related hedging flows and client orders, including stop-loss orders". The BIS added that the profile of option hedging requirements might have meant dealers had a "large" barrier option exposure. Prior to the publication of the report, media outlets had speculated that a "rogue algorithm" or a "fat finger" caused the flash crash. While these were not ruled out by the report, it noted that there is, "little, if any, hard data to substantiate" the claims.

Illiquidity associated with the time at which the event occurred (shortly after midnight UTC) was thought by the BIS to have exacerbated the selling, as were regional bank holidays, particularly that in China. The bank noted that trading outside the "currency's core time zone" meant that traders involved in sterling might have been "less experienced" and had "lower risk limits and risk appetite".

Regulatory changes might also have affected trading, with the BIS stating that, "some traders' participation during the event may have been constrained as a result of concerns around potential market and conduct risks associated with trading in illiquid markets away from previous prevailing price levels".

No particular type of market participant was singled out, with the BIS saying: "Those withdrawing liquidity cannot be readily categorised by type of institution," and that, "some firms withdrew first from voice trading, others from e-trading". Equally, "for some it was their algorithmic trading that restarted first (although often with human intervention to allow the restart), for others their voice activity".

That said, there was what could be taken as a veiled criticism of the CME in the report: "The fact that the futures exchange was halted for a large proportion of the event may have further amplified the dysfunction in the cash market."

The Bank of England's own report on the flash crash is expected later in the first quarter.

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