Market Disruption Caused by Algo Trading

As announced on 14 Feb 2018, SFC reprimanded and fined Interactive Brokers Hong Kong Limited (IBHK) $4.5 million after resolving concerns over IBHK's breaches of the Code of Conduct in its execution of market orders using electronic and algorithmic trading systems.

SFC's disciplinary action followed two market disruption incidents in 2015 and 2016 where the share prices of HK-listed O-Net Communications (Group) Limited and AAG Energy Holdings Limited were ramped up by 48.7% and 126% respectively, in less than two minutes.

In light of the incidents, SFC and IBHK jointly engaged an independent reviewer to review IBHK's electronic and algorithmic trading systems, in particular, the controls to monitor and prevent the generation of or passing to the market for execution order instructions which may interfere with the operation of a fair and orderly market.

The review found that, in the two incidents, IBHK executed market orders by placing the entire order volume to the market and repeatedly submitting the unexecuted part of the order at the next available price until the entire order was completed. It also found that IBHK did not take into account the liquidity of the market when executing the market orders. Furthermore, IBHK failed to put in place effective price and volume controls to prevent its execution of market orders from disrupting the market.

Para 3.3.1 of Schedule 7 to the CoC provides that a licensed person should have controls that are reasonably designed to monitor and prevent the generation of or passing to the market for execution order instructions from its algorithmic trading system which may interfere with the operation of a fair and orderly market.

In respect of IBHK's electronic and algorithmic trading systems, the review indicated that:

• IBHK's electronic trading system was developed by its head office in the United States, where its programming function was responsible for both development and quality assurance of the system. IBHK did not conduct adequate user acceptance testing on the system; and
• the technical design documents of the systems were high level and did not provide a detailed explanation of the components of the trading systems. A specific example is that IBHK did not keep adequate records in relation to the design, development, deployment or operation of the order cancellation functionality in its electronic trading system.

Para 3.2 of Schedule 7 to the CoC provides that a licensed person should ensure that the algorithmic trading system and trading algorithms it uses are adequately tested to ensure that they operate as designed. Para 1.3 and 3.4 provide that a licensed person should keep proper records on the design, development, deployment and operation of its electronic trading system.

This was a rare enforcement case against algo trading. For more technical details, please refer to the SDA.