FCA Report: Algorithmic trading compliance in wholesale markets

• Relevant to both solo- and dual-regulated firms, the report reflects the findings of both firm-specific and cross-firm reviews into algo trading undertaken in the run-up to MiFID II implementation.
• Within the introduction, the FCA lists relevant MiFID II requirements, noting that "firms should reference a number of pieces of legislation when developing algorithmic trading practices and procedures".
• FCA sets out five key areas of focus and sets out its objective under each area; these are then used to structure the report's examples of good and poor practices:

• Defining algo trading
• Objective: to ensure firms establish an appropriate process to identify algo trading, manage 'material changes', and maintain a comprehensive inventory of algo trading across the business
• Development and testing
• Objective: to ensure firms maintain robust, consistent and well understood development and testing processes which identify and reduce potential trading risks across trading algos prior to full deployment
• Risk controls
• Objective: to ensure firms develop suitable and robust pre- and post-trade controls to monitor, identify and reduce potential trading risks across algo trading activity
• Governance and oversight
• Objective: to ensure firms maintain an appropriate governance and oversight framework which demonstrates effective challenge from senior management, risk management and compliance on algo trading activities
• Market conduct
• Objective: to ensure firms appropriately consider the potential impact of their algo trading on market integrity, monitor for potential conduct issues, and reduce market abuse risks

Comment: The focus is very much on operating robust and sensible governance and controls, mitigating the risk to the FCA's objective of enhancing market integrity.  FCA has a clear expectation that regulatory requirements are prominently factored into product/process/strategy development process, including controls development, at an early stage.

PRA Consultation (CP5/18): Algorithmic trading

• The Consultation is relevant to dual-regulated firms subject to the rules in the Algorithmic Trading Part of the PRA Rulebook and Commission Delegated Regulation EU 2017/589.
• The draft SS would apply to all algo trading of a firm including in respect of unregulated financial instruments, e.g., Spot FX.
• The SS is structured in five sections; a summary of the proposals by section follows:
• Governance:
  • A firm's governing body should explicitly approve the governance framework for algo trading.
  • A firm's management body should identify the relevant Senior Management Function(s) with responsibility for algo trading.
• Algo approval process:
  • A firm should have a robust approval process with clear scope and conditions for approval.
  • Prior to granting approval, each algo should have assigned owners and have completed testing across all relevant parties (e.g., front office, risk management, other systems and controls functions).
• Testing and deployment:
  • All algos and risk controls should be tested prior to deployment and subject to periodic re-validation.
• Inventories and documentation:
  • Firms should create and maintain: comprehensive inventories of algos and risk controls; and documentation of each algo's strategy and risk mitigants, kill-switch control procedures and the algo trading system architecture.
• Risk management and other systems and controls functions:
  • A firm's risk management (which is independent of the Front Office) and other systems and controls functions should have oversight of the risks of algo trading.
  • The PRA expects those functions to have authority and expertise to challenge Front Office and to impose on algo trading whatever additional risk controls are necessary to effective risk management.

Comment: As with the FCA report, the PRA consultation is very focused on governance and controls. Firms may need to think about how they evidence that risk management/other systems and controls functions have the authority and expertise to challenge Front Office and impose additional risk controls.