GreySpark Study Yields Pre-Trade Risk Best Practices

According to GreySpark, the paper ─ Best Practices in Pre-trade Risk Controls 2014 ─ provides banks with a guide that enables them to develop and implement barriers surrounding their e-trading systems in order to prevent similar situations to the Knight Capital fiasco on the August 1, 2012, when the New York-based market maker suffered losses of some $440 million due to the accidental release of test software code into its production environment.

The consultancy claims that investment banks are taking on increased levels of risk during the course of their business as they look to move into new markets and asset classes, even though the complexity of electronic trading systems continues to rise. Recent examples of malfunctions within e-trading execution platforms like those that affected Knight Capital, and the Flash Crash of May 6, 2010, which saw the Dow Jones Industrial Average lose approximately 1000 points (9 percent) only to recover those losses within minutes, highlight the need for better risk controls ─ specifically on a pre-trade basis ─ which the report focuses on.

Checklist
The study, published on August 8, provides tier-I and tier-II sell-side firms with what it calls a "checklist-like set of controls that can be tailored to the specific requirements of different types of sell-side institutions."

The firm's recommended pre-trade risk controls include details about the design and implementation of execution platforms, guidelines on managing pre-trade risks associated with both sell-side capital markets agency flow businesses and principal flow businesses, and reviewing how risk limits should be implemented across multiple, independent pre-trade components utilized by both models. It also explores sell-side pre-trade risk industry best practices and explains how such controls can be applied to order flow risks within banks. GreySpark insists that the majority of banks can adopt these pre-trade risk controls with only minor modifications to their technology stacks.

The paper provides banks with a guide that enables them to develop and implement barriers surrounding their e-trading systems in order to prevent similar situations to the Knight Capital fiasco.