Nasdaq liked the idea of real-time market surveillance so much that
it bought one of the companies that specialize in it.
Nasdaq OMX announced this week that it will buy Smarts Group, an
Australia-based market surveillance business that helps exchanges monitor
compliance with trading rules. You can read the full story here: http://online.wsj.com/article/BT-CO-20100727-712964.html.
The market moves a lot faster than it used to thanks to algorithmic
trading. What has not kept pace is monitoring high speed trading. Smarts is one
commercial approach that aims to enable such monitoring. However, there is a
big problem with Smarts - the time it takes to develop a new surveillance
scenario. I have spoken to a number of venues around the world, including the
Australian Stock Exchange, who have told me they are totally dependent on
Smarts to add new rules when they need one – and it takes 6 months to a year – if
they’re lucky. In fast-moving markets we need to evolve in hours not years!!
Despite shortcomings with Smarts, the Nasdaq acquisition is an
indicator of the importance of real-time surveillance in a post-flashcrash
world. Maybe the flash crash of May 6th has a silver lining if lessons learned
are leading exchanges to better use surveillance and monitoring. In the
aftermath of the crash, exchanges scrambled to recover trading data and do some
forensic investigation into the causes. This proved extremely difficult
probably because of inadequate analysis capabilities to pinpoint what had
Exchanges, ECNs, brokers, traders and regulators all must take an
intelligent approach to monitoring and surveillance in order to prevent rogue
trades and fat fingers. Transparency is the key. Regulators in the US and
Europe are concerned about the lack of transparency in markets where high
frequency algorithmic trading takes place, as well as in dark pools.
We ran a survey at SIFMA this year where we asked 125 attendees
about high frequency trading and market surveillance. A staggering 83 percent
said that increased transparency is needed to effectively deal with market
abuse and irregular market activity, such as the flash crash. However, only 53
percent of firms surveyed currently have real-time monitoring systems in place.
Nasdaq says that Smarts will be used to expand broker surveillance
solutions, which I take to mean monitoring scenarios such as sponsored access.
This would be a smart move (forgive the pun). With naked access, high frequency
traders can plug straight into an exchange through their broker – and it’s
critical that pre-trade risk and surveillance is in place to prevent a crisis
in which wild algos could cause havoc.
The detection of abusive patterns or fat fingered mistakes must
happen in real-time, ideally before it has a chance to move the market. This
approach should be taken on board not just by the regulators, but by the
industry as a whole. Only then can it be one step ahead of market abuse and
trading errors that cause a meltdown (or up).
As many market participants have pointed out, technology can't solve
all of the problems, but it can help to give much more market transparency. To
restore confidence in capital markets, organizations involved in trading need
to have a much more accurate, real-time view on what's going on. In this way,
issues can be prevented or at least identified much more quickly.
While I applaud Nasdaq's initiative and dedication to improving
market surveillance buying Smarts, I must point out that you don't have to go
quite that far to get the same results. Progress provides market-leading
real-time monitoring, surveillance and pre-trade risk – powered by Complex
Event Processing – enabling complex real-time monitoring of the fastest moving markets.
Unlike Smarts, Progress includes the ability for business users to customize
and create new scenarios rapidly (in hours rather than Smart’s months). And you
don’t have to buy and integrate our company to get access to it!!
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