Trading Floor Tremors - Big Data To The Rescue

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  • New regulation of financial trading is coming on-line to improve transparency and compliance
  • 'Big data' products provide the necessary horse-power, but financial institutions need to act

"It only takes four seconds to invest thousands of million of pounds", said Jérôme Kerviel, the now-imprisoned rogue trader. While it makes me wonder whether I'm in the right business, his and other similar stories do emphasize the very thin red line between huge success and ruinous behaviour in the financial trading world, where ultra-low latency financial networks operating at the speed of light create huge waves from even a single error - intentional or not.

A typical 'fat finger' story is the Japanese trader, who wanted to sell one share for 650,000 yen, but got the key-in sequence wrong and offered 650,000 shares for 1 yen apiece! The Tokyo Stock Exchange had to close for business two hours to unwind all the millions of purchase placements that followed. Similarly, a Lehman Brothers dealer in London 12 years ago wiped £30bn off the FTSE when he inadvertently ordered sales of shares in blue-chip companies such as BP and AstraZeneca that were 100 times larger than intended. The reaction to these and similar events has been stricter regulation, not only in the forensics department - finding out what actually happened after the catastrophic event - but also better proactive capabilities to spot and stop a disastrous deal from closing at all.

Millions of high-volume trading deals are being transacted every minute across many trading platforms (IPC, BT ITS, Etrali, Speakerbus, Siemens, Mitel, Adaptive Trading etc.) and carried over global financial networks like BT's Radianz and Orange Business Services Flexible Trading Service. The financial crisis led regulators to feverishly attempt to reign in trading transgressions, in order to create more transparency. The most important acts are the US Dodd-Frank Wall Street Reform and Consumer Protection Act (D-F), which applies to any financial institution with operations in the USA; and EU MiFID (The Markets in Financial Instruments Directive 2004/39/EC). D-F is in on-going implementation mode (despite some delays), second generation MiFID II is a work-in-progress.

Both sets of regulations are mammoth undertakings, and some estimates put the decade-long cost of implementing these measures by US financial institutions at over $20bn. The rules are neither completely rolled out (that will take ten years), nor cast in stone, as exemplified by the data retention period originally set to 3 years but then reduced to 12 months after massive industry protests. This makes it difficult for compliance software developers to provide the right compliance tools, and makes it difficult for the financial institutions to adopt the right implementation strategy. Generally, they will have to proceed with a bolt-on implementation to meet specific oversight demands, such as the swap trade monitoring, which must be in place in Q1 2014. However, financial institutions should also view this as an opportunity to beef up their own internal controls of trader activities - rogue trading can be very expensive!

D-F basically applies to companies with more than $3bn in transactions, and requires swap trading companies to document thoroughly any deal within 72-hours if so requested by a regulator. That documentation must include all voice, mail and chat data relating to a specific deal. Previously, trading floor managers had to rely on log files and transcripts to stitch together the details around a specific deal - a laborious task - and of course only completed a long time after the horses had bolted from the stable.

Enter 'big data' and a 3-step implementation process.

The ability of big data products to handle large volumes of unstructured data is clearly the first step towards a highly scalable, near real-time monitoring of trading activities. The second step is developing applications that can rapidly synthesize the data and generate reports in the formats required by D-F and MiFID (the latter is rather difficult as MiFID II is still undergoing review, and the two sets of legislation are not fully aligned, so full compliance with both is right now a real challenge).

D-F compliance applications are now becoming available to financial institutions, investment banks, institutional investors, hedge funds etc., from companies like CGI Group, Traiana and Fonetic. However, given that the fast-approaching drop-dead D-F compliance date set to end of Q1 2014, the general state of market preparedness in the financial institutions, and government alignment of regulations in major markets like the UK, France and Germany, is lacking.

The third step in this process is to develop applications that can spot non-compliant deals e.g. when a trader suggests in an email to his counterpart that a deal is finalized 'over lunch' i.e. outside the range of deal-monitoring systems, and the monitoring system then alerts a compliance manager. This final step is still under development and is not yet a D-F requirement, but follows logically from investments in the first two steps.

Implementation of a D-F compliant solution will cost a financial institution anywhere from $50-200 million, depending on number of locations, traders, languages and data sources to be monitored. With an investment of this magnitude, the institutions will clearly want more than just the ability to satisfy the financial regulators. They want to stop rogue traders at an earlier stage, they want to see improvements in their data leakage prevention capabilities, and they want to use the data to assess the efficiency of their traders and trading programs. Once such functions become available, smaller financial institutions will also want access to such tools. To achieve an acceptable price point for these customers, we expect to see more cloud-based software as a service offering emerge.  

Clearly, the large financial institutions need to speed up their compliance processes, and especially the European governments on their side need to hammer out MiFID II guidelines. This should initially address swap trading in the ten major financial centers and the five major languages used by them.

Overall, there are improvements in transparency and critical analysis of trading activities, but threats are still faced from fast (but erroneous or malicious) information flows, affecting the stock markets worldwide, as it did earlier this year. On April 23rd, $130bn was temporarily wiped off the value of stocks in the S&P 500 after the Associated Press Twitter account was hacked and a false message stated that 'Two explosions hit the White House. Obama injured'. The Dow Jones dropped 100 points in less than a minute.  So today, it's not just rogue traders who can 'invest' £1000's of millions in few seconds; misinformation and lack of real-time compliance tools can also cost investors huge sums of money.

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This page contains a single entry by Bernt Ostergaard published on June 17, 2013 11:02 AM.

Is Cisco = HP + Ericsson? Developing End-to-End DC Solutions was the previous entry in this blog.

Employees and employers seem to agree: wasting money is OK. is the next entry in this blog.

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