Standards & Algo’s: Innovation or Control?

The SEC is socializing the notion of standards in the world of algorithms. Throttles, brakes, back testing and other coding requirements are all on the table. Will these and likely other requirements stifle the creativity and innovation of a market where secrecy and the ability to react with lightning speed to inefficiencies is core to the business? Or does this make it a safer playing field for all?

The recent question of standards seems less about quality control than the ability to lay blame and create liability for those involved. Will the recent announcement that traders will be required to take the series 56 exam specific to program trading in equities make an accident less likely? One would think it ineffectual when it comes to the proverbial “fat finger” but as a tool for investigators in building a case against a firm it becomes valuable in supporting the “you have no excuse for not knowing” argument.

Technology has taken the markets to new highs and back again with lightning speed and rest assured it will happen again. The market is about risk. Risk not only for the investor, but also for those who facilitate the markets in the form of operational risk. Shouldn’t solving for events like the “flash crash” also focus on speeding the dissemination of information to alert market participants that there was an error? Beyond that, innovation is about taking risk. The industry should ensure that standards don’t try to eliminate risk, as without risk no one makes a profit.

There were many desks on the day of the flash crash that immediately recognized the anomaly and turned off their models and programs. No, throttle, break or standard; just experienced people, paying attention and managing risk.

Markets thrive on innovation. To the extent that regulation frustrates innovation, it may make markets less rather than more efficient. Standardizing algorithms takes the market back in time without addressing the root cause of the problem – namely that markets are prone to human error. Granted, technology may amplify mistakes, but it also provides the capacity for rapid self-correction. The caution is: avoid diluting the value of technology in an effort to protect us from our innate human frailties.