Algorithmic trading: Are you covered?
The pace of technological change in the asset management sector has been rapid. The rise in electronic trading platforms and increased availability of data...
...has increased the application of algorithmic trading, both for execution and investment decisions.
The pace of technological change in the asset management sector has been rapid. The rise in electronic trading platforms and increased availability of data has increased the application of algorithmic trading, both for execution and investment decisions.
The Financial Conduct Authority (FCA) has recently highlighted examples of good and poor practice of firms employing algorithmic trading techniques.
Their report, titled Algorithmic Trading Compliance in Wholesale Markets was published on 12 February 2018. In it the FCA say “In the absence of appropriate systems and controls, the increased speed and complexity of financial markets can turn otherwise manageable errors into extreme events with potentially wide-spread implications."
Learnings from the report
The increased execution speed and lowered costs can benefit investors but for firms it can amplify certain risks. The report says that some firms "...lacked a suitable process to identify algorithmic trading across their business and did not have appropriate documentation in place to demonstrate suitable development and testing procedures are maintained". They also said these firms "need to do more work to identify and reduce potential conduct risks created by their algorithmic trading strategies".
The FCA paper discusses several regulatory areas algorithmic trading touches, including the new Senior Managers & Certification Regime.
The paper also highlights several areas of good practice for asset management firms; from risk management and recovery plans, to firm culture, training and senior management engagement.
Evolving insurance solutions
The asset management insurance products designed to respond when errors are made need to evolve to ensure they respond to these changes.
Protection against operational risk with immediate availability of insurance proceeds to limit harm to reputation and compensate investors requires your professional indemnity insurance policy to be fit for purpose, especially in allowing you to act quickly and without prior approval of insurers.
The speed of algorithmic trading requires fast action, but the potential scale means potential losses may be above traditional internal insurance policy limits.
The FCA will continue to assess whether firms have taken sufficient steps to reduce risks arising from algorithmic trading. It said in the report: "It is essential that key oversight functions, including compliance and risk management, keep pace with technological advancements. As a result, algorithmic trading continues to be an area of focus for the FCA and other regulators across the globe."
What can you do to protect yourself and your firm
Whilst avoiding an incident in the first place is preferable, the right insurance cover will help you recover should the worst happen. Make sure you understand how your insurance will respond in the event of an incident. You should also be prepared to describe how your firm meets ‘good practice’ or changes you are making in light of the FCA report in order to get the best from your insurance renewal, both in terms of premium and policy coverage.
Our Professional & Executive Risk team have experience working with asset management clients around the world to transfer operational risks by ensuring insurance policies respond. Our client advisers and in-house policy lawyer will be pleased to discuss further and conduct a free, confidential and no obligation review of your current insurance policy to ensure it is fit for your business.
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