RiskTech Forum

ClusterSeven: Algorithmic and High-frequency Trading needs Spreadsheet Management for MiFID II

Posted: 1 November 2017  |  Author: Henry Umney  |  Source: Cluster Seven Services Ltd


With the EU’s Markets in Financial Instruments Directive (MiFID) II taking effect from 03 January 2018, organisations need to start planning for implementing the changes the legislation demands. It is a sweeping legislation, affecting a variety of organisations – from interdealer brokers to investment banks and stockbrokers though to data reporting services providers. The affect of the legislation is wide ranging on organisations themselves too, impacting functions including client services, trading, transaction reporting, IT systems and more.

Specifically, MiFID II introduces a number of changes that are relevant to organisations that use algorithmic and high-frequency trading (HFT) strategies. Clearly, the regulator recognises the growth of these strategies, and while well-disposed to their use, it acknowledges the potential risk they pose, which could lead to disorderly markets. Therefore, the legislation is increasing scrutiny on firms adopting algorithmic and HFT strategies so that the regulators are able to pursue traders who attempt to manipulate the prices of financial instruments. In fact, organisations are required to accurately record (time sequenced) when every single order is submitted, executed – along with quotations on trading venues – for a minimum of five years.

Consequently, MiFID II requires algorithmic traders to have effective systems and controls in place for record keeping and approval. Given the extensive reliance of organisations on spreadsheets for data feeds, modelling and manipulation, an automated approach to spreadsheet management and control will greatly help organisations to comply with these core components of MiFID II.

For instance, MiFID demands a full sign off of workflow processes from all business functions – i.e. market risk, credit risk, operational risk and compliance – to any changes to algorithms that have connections to the market. So, wherever organisations use Excel spreadsheets to connect to APIs and trading gateways, there will need to be auditable controls around the spreadsheet models that feed the algorithmic trading network. Any updates to pricing methodologies that are fed into the algorithm will need to be tested to ensure compatibility, along with an audit trail to demonstrate evidence of the process. Similarly, when new algorithms are created, organisations will need to demonstrate evidence that the new templates have been properly tested and signed off before going into production.

Given the complexity of HFT spreadsheets that feed data into the algorithms, manually undertaking the processes to demonstrate compliance will be neigh impossible. On the other hand, with automated spreadsheet management, organisations will be able to build-in workflows in to their business processes for change management, testing and so on to demonstrate compliance as a matter of routine. In fact, organisations will also be able to use the evidence generated to communicate the changes in the algorithms to the National Crime Agency (NCA), which is mandatory for organisations.

Organisations involved in algorithmic and HFT strategies will be required to perform regular stress testing to ensure that in the event of a market crisis, their algorithms do not act in a disorderly way to compound the situation. Spreadsheet management solutions will help organisations to create a comprehensive inventory of all the algorithms and the various spreadsheet-based data sources that feed them. This will provide them with complete visibility of the algorithms that are in scope. Thereafter, with automated spreadsheet control processes in place, firms will be able to see the inputs to the algorithms at a granular level and where required even allow the organisation to retrace steps across the execution process of trades.
Similar to many other legislative and regulatory requirements, the driving force behind MiFID too is about transparency. Additionally, the legislation aims to ensure that the ‘powers that be’ (who may not necessarily be directly involved in the trading function) take responsibility of how trades are executed and administered. An automated approach to spreadsheet management will ensure that all the necessary best practice processes are embedded into the organisation via automation and hence followed routinely by firms engaged in algorithmic and HFT strategies. We are helping a number of organisations to meet these new MiFID II requirements. If this is an area you are exploring, get in touch with us.