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Markets must learn from pound flash crash, says BIS

Fragile market conditions, poorly controlled algorithms and inexperienced staff all contributed to last October’s flash crash in sterling, global policymakers have concluded, with the Bank for International Settlements urging banks and other market participants to learn from their mistakes.

The BIS — the central bank for central banks — said on Friday that no single event was responsible for the extraordinary 9 per cent plunge in the pound in the usually sleepy early Asian trading hours of October 7. It rejected early theories that the publication of a Financial Times article about the French president’s views on Brexit negotiations was to blame.

The BIS said policymakers and market participants around the world must learn from the event, the latest in a series of recent flash crashes globally. Banks and other traders should “fine tune systems and processes” and ensure they better understand how the rise of electronic trading has created strains in the market’s infrastructure.

“The combination of new participants, changes in market-making and the advance of technology raises important questions about the evolving nature of liquidity and resilience in financial markets — and the possible impact on the real economy — that policymakers should address,” the BIS said in its 25-page report.

The study does not name particular people or institutions, but points to idiosyncratic factors that coincided with widespread pessimism over the currency in the wake of the UK’s vote to leave the EU in June.

“The presence, outside the currency’s core timezone, of staff less experienced in trading sterling, with lower risk limits and risk appetite, and with less expertise in the suitability of particular algorithms for the prevailing market conditions, appears to have further amplified the movement,” it says.

As first reported by the FT, UK authorities are stepping up their inquiries, with supervisors at the Bank of England and the Financial Conduct Authority grilling Citigroup over the role of its staff and over controls on its algorithms in place that night.

A fat-finger error or even market abuse could not be ruled out, Friday’s report said — although it conceded that there was little hard evidence to back this up.

The plunge in the value of the pound against the dollar, during which it dropped from $1.26 to as low as $1.14 on some systems, can be traced in distinct stages, BIS said.

UK supervisory data point to a significant increase in certain market participants’ share of trading activity as others withdrew — suggesting a role for idiosyncratic factors

The first came at seven minutes past midnight London time, around the time that the FT reported French calls for a tough stance towards the UK over Brexit — a story that may have played a “marginal” role, according to the BIS. Clusters of options contracts and of resting orders to sell sterling created a perfect environment for a dip to become unusually pronounced.

Then, the BIS notes there were several minutes of “extreme dysfunction” that hammered the currency before a rebound. During that period, individual traders could have had a magnified effect on the market, it added.

“Indeed, UK supervisory data point to a significant increase in certain market participants’ share of trading activity as others withdrew — suggesting a role for idiosyncratic factors in driving the extreme dysfunction observed as sterling traded at levels well below 1.20 against the dollar,” the BIS said.

The crash occurred at a time in the day not typical for trading sterling in large amounts, and Chinese markets were closed for a holiday, thinning out flows and leaving markets difficult to navigate, the report notes.

It also points out that some traders may have felt unable to share information to cool the chaos, for fear of breaching conduct requirements. That is a particular black spot for this market, with some former traders this week facing US charges over their communications in a chatroom known as “The Cartel”. The BIS has sought to give traders a suitable framework for discussing market moves with a new code of conduct.

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