The China Securities Regulatory Commission is investigating the stock trading systems of more than 110 Chinese brokerages in the wake of the largest erroneous trade in the country’s stock market history, Reuters reported. In particular, the agency plans to determine whether design flaws in the product of a Shanghai-based high-frequency trading software company were responsible for unleashing market turmoil.
The trading error occurred on August 16, when brokerage Everbright Securities issued a series of 26,082 buy orders to the Shanghai Stock Exchange totaling 23.4 billion yuan, equivalent to $3.82 billion, over the course of two minutes. The intended trade value was supposed to be just three batch orders worth 5.5 million yuan, the South China Morning Post reported. As a result of the trades, China’s CSI300 Index saw a flash rally that created and erased $100 billion of share value in one day, according to Reuters. The CRSC chose to expand its probe of the incident to encompass all of China’s brokerages following its initial investigation of the software company that built Everbright’s custom system. The agency is attempting to find out whether the glitch was a result of design flaws in the program.
Building safe trading software
Despite initial theories that the error was prompted by a trader pressing the wrong button, the initial CSRC findings suggested that there was an underlying system flaw, the South China Morning Post reported.
“The investigation did not show human error, but China Everbright Securities has an obvious flaw in its system design and risk control,” the CSRC on its website, according to the SCMP translation. “The Shanghai CSRC has ordered the firm to suspend the related business and to make an internal investigation to … make improvements.”
The software used by Everbright is made by Mercrtsoft, a vendor that supplies many Chinese trust companies, hedge funds and securities brokerages. Everbright commissioned a specially designed version of the high-frequency trading software, according to Chinese news agency Xinhua. Mercrtsoft announced on its website that it is “actively cooperating” with the investigation, Reuters reported.
The incident has highlighted some of the issues with technology among China’s brokerages, which cut IT spending by 13.4 percent from 2010 to 2012, according to Beijing IT consultancy CCW Research. According to Guo Chang, deputy general manager at CCW Research, the Everbright incident should be a wake up call that such neglect of IT systems needs to stop for trading technology to keep up with the increasing sophistication of the market.
“When it comes to new financial products and business lines, the finance industry people understand the risks, but they’re not familiar with how to use technology to mitigate those risks. They don’t understand IT,” Guo told Reuters.
Everbright, the ninth-largest brokerage on China’s mainland, said it suffered a loss of 194 million yuan due to the incident, the South China Morning Post reported. The company’s current president has been replaced, and its head of proprietary trading was suspended, according to Reuters. Its stock has lost 17.6 percent of its value since August 16.
Such incidents have become an increasingly common risk on today’s markets, where much of the trading is handled algorithmically. A few days after the Everbright incident, a system at American firm Goldman Sachs placed a flood of erroneous orders on the NYSE Amex Options market, driving down many stock-option prices. Last year, a software bug led to mistaken orders that caused Knight Capital to lose more than $440 million.
To avoid unleashing such mayhem on the markets, financial services firms should look to eliminate bugs in their trading systems during the production process. By using source code analysis software or insisting their partners implement a similar code review standard, companies can minimize the risk of a mistaken trade causing financial disaster.
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