Sell-Side Tech Glitches Provide Lessons for the Buy Side

“Three makes a trend”—the journalist’s credo—informs many of the topics we cover in Waters magazine. So when three major incidents involving technology glitches in the capital markets make headlines over the course of just seven days, it’s hard not to look for commonalities among them.

Linking together the incidents at Knight Capital, the Tokyo Stock Exchange (TSE) and the Bolsas y Mercados Españoles (BME) in a meaningful way points to a discussion about disaster recovery and the fragility or robustness of the technology that underpins the trillions of dollars that pulse through the markets each day, rather than any similarities among the incidents themselves.

Even though, for example, the Knight incident and a slightly less noteworthy fourth incident—the Egyptian Exchange (EGX) was shut down for two hours yesterday after power outages wreaked havoc across the country—each resulted in trading interruptions, power outages and rogue algorithms are of course very different.

Whether preventable, as in the case of a bad piece of software, or not, as with extreme weather events, the best defense against trading interruptions are robust risk management systems and disaster recovery plans. What we’ve seen over the last week is several of these events in a cluster, which causes everybody to freak out.

Yet there are still more ways to draw parallels between these failings. Keith Ducker, chief investment officer at Tora Trading, which provides a multi-broker electronic trading platform for Asia, says we may see more tech glitches ripple through the industry because financial IT across the globe is in a weakened state after massive budget cuts and layoffs in 2008, 2009, and even 2010. Everyone is playing a game of catch-up.

"In our opinion, post-2008 financial crisis, firms had under-spent on technology budgets as volumes or revenues had declined," Ducker says. "Some of them now may understand that the cut might have been a mistake."

What happened at Knight, TSE, BME and EGX—and along with the botched Bats and Facebook IPOs earlier this year—are mainly sell-side issues, but they have created much anxiety on the buy side. And to Ducker's point, as the buy side experiments more and more with algorithmic trading and new assets to trade in, the need for improved testing capabilities and infrastructure investment is as important as ever.

Even if it's not entirely accurate to call these events a trend, they also didn’t happen in a vacuum. For hedge funds and asset managers to simply say that exchanges and brokers need to improve their offerings would be short sighted and—as was learned at Knight—extremely dangerous.