The Netherlands Authority for the Financial Markets recently released a report on its expectations around the current and future use of internal controls for automated trading. This is an important theme for FIA EPTA and we are pleased to see that the AFM's report sets clear principles and shows the importance of industry best practice and the principles of proportionality.
One of the most notable features of the AFM report is the regulator's insistence that the need for internal controls is applicable to all forms of automated trading, rather than just firms that use high-frequency trading. We think this is an important principle because of the rapid diffusion of automated trading technology. In today's markets, the risks of automated trading can come from almost any type of firm.
As the AFM noted in its report, the guidelines on automated trading published by the European Securities and Markets Authority in 2012 were very clear on this, but unfortunately this has been "regularly misinterpreted."
“The AFM has observed that some firms take the view that the ESMA Guidelines do not apply to them because they do not use HFT techniques. The ESMA Guidelines, however, clearly state that … any firm sending orders to a trading venue by electronic means (either using algorithms and/or electronic trading systems, irrespective of whether the trading decision itself has been made by humans or not) falls within the scope of the ESMA Guidelines.”
It is also worth noting the contrast with a recent paper issued by the Senior Supervisors Group, a body that consists mainly of banking regulators. The SSG paper focused almost entirely on risk and control principles for high frequency trading. This approach will likely compound the misinterpretation of the ESMA Guidelines that is of concern to the AFM.
Another notable feature of the AFM report is that it extends beyond the ESMA Guidelines to emphasise the importance of industry actions to raise operational and risk management standards. The AFM report explicitly references the FIA Guide to the Development and Operation of Automated Trading Systems as a leading example of industry bodies assisting firms in staying abreast of current market developments and best practices.
Most importantly, the AFM report also shows a clear understanding of the principles of proportionality, and the variations in risk profile caused by differences in the nature, size and complexity of trading firms. The AFM is clear that firms are free to make different choices around the exact nature of compliance and risk management functions they employ according to their particular structure and risk profile. Much of the European legislation currently in progress and under review fails to adequately account for the principle of proportionality in its requirements. This is a great concern to the many small trading firms in Europe. Unless this is rectified, the impact of the new requirements may be so great that operating in Europe could cease to be viable.
By taking an approach to regulation which sets clear principles and shows a clear understanding of industry best practice and the principles of proportionality, regulators allow the markets the greatest scope to grow and develop within the regulatory framework and to maintain the diversity of the market ecosystem. Kudos to the AFM for getting this right.
The views expressed in this blog post are the personal opinions of the author and do not necessarily reflect the official policies or positions of the FIA European Principal Traders Association or the Futures Industry Association
- FIA EPTA