End-to-end testing of trading infrastructure is critical in today’s increasingly heavily regulated environment – but compliance comes at a price. So why should financial firms pay it, and what happens if they don’t? In our second blog post on the topic, we explore the most pressing reasons to implement a robust testing mechanism.
The most obvious catalyst for ensuring a robust testing process is of course the need for compliance. The regulatory demands for trading system testing have never been higher, and MiFID II requires all trading firms to certify that their algorithms have been tested to ensure that they do not create or contribute to disorderly trading conditions before being deployed in live markets.
But there can be some confusion about whom this applies to – and financial services firms should ensure they don’t get caught out. National regulation, such as the consultation paper released by the Bank of England in February 2018, CP5/18 Algorithmic trading, provides some insight into what is required, including governance, testing, and attestation requirements. However, while some firms may believe themselves exempt as they do not execute algorithmic trading, regulatory requirements can vary by jurisdiction.
For example, the FCA considers Market on Close orders as algorithms, while in other jurisdictions go as far as determining the procedures by which executives have to sign off on the testing – which could include MiFID II’s highly prescriptive latency measurements for the trading technology stack. In the US, FINRA Rule 3110 (Supervision) specifies that all regulated broker dealers must test algorithmic trading programs.
Setting aside regulatory obligations however, there is a more pragmatic argument for putting in place a robust testing framework – the benefit of reduced operational risk. Senior management and the board should be raising concerns if they do not receive regular reports on the fitness of the firm’s trading systems. Executive management should also be made aware of potential operational efficiencies, and the increase in the overall quality of the trading operations, if investment is made in improving testing procedures. Such an investment may even reduce costs – and this argument is becoming ever more compelling.
Before the Financial Crisis, the potential savings that could be made by adopting an improved testing environment were rendered insignificant by the huge profits that firms were making from trading. In today’s tight markets, trading profits aren’t quite so abundant. Electronic trading is coming under the same cost pressures as the retail and manufacturing sectors, where driving out operational costs is a strategic imperative. So, while the regulatory response is forcing firms to invest more in testing – and there are fewer catastrophic failures as a result – the cost of this testing is eating into balance sheets. Trading system testing now needs to be made more efficient/effective.
Solutions such as VeriFIX can help automate the costly and error-prone process of manually testing trading systems, and reduce dependencies on counterparty test environments. It enables both buy and sell-side institutions to quickly simulate environments to dramatically optimize the testing cycle, allowing firms to realize significant efficiencies before “going live” with complex deployments. It also enables testing rare race conditions and complex scenario which are not easily encountered in counterparty test environment but which can cause havoc in production environments.
In today’s complex and compliance-oriented environment, solutions such as VeriFIX are essential not only to meet regulatory requirements, but to create an optimum risk environment at the low total cost of operations.
Download the white paper
Trading infrastructure testing: taking an enterprise approach.