The SEC Market Trading Technology Roundtable, which took place in Washington, has already generated a very rare joint letter by the major stock exchanges that proposes creating a “kill switch” in an effort to control runaway algorithms, among other issues.
The exchanges are recognizing, and SEC Chairman Mary Schapiro is agreeing, that there is a potential hole in their risk management system: the presence of single-stock circuit breakers and “clearly erroneous” trading rules that allow the exchanges to bust bad trades did not prevent the kind of runaway algorithm generated by Knight Capital on August 1.
A “kill switch,” in its most simple form, would allow exchanges to set limits on the categories of activities that their firms are allowed to engage in, and shut them down if they exceed those limits. It would limit the total exposure each firm has to the market.
Of course, there has to be some kind of quantitative, clear, dynamic method for determining if someone’s algorithm is really out of control, or is just appropriately behaving. That is the challenge all market participants will want to have a say on.