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Does the deployment of algorithms combined with direct electronic access increase conduct risk? Evidence from the LME

Does the deployment of algorithms combined with direct electronic access increase conduct risk? Evidence from the LME
Does the deployment of algorithms combined with direct electronic access increase conduct risk? Evidence from the LME
Purpose– The purpose of this paper is to examine the effectiveness of two regulatory initiatives in developing awareness of conduct risk associated with algorithmic and direct-electronic access (DEA) trading at broker-dealers: the UK Financial Conduct Authority’s algorithmic trading compliance in the wholesale markets and Commission Delegated Regulation 2017/589 (CDR 589) to the second Markets in Financial Instruments Directive. Design/methodology/approach– A qualitative examination of 15 semi-structured interviews with representatives of London Metal Exchangemember firms, theirclients andregulators. Findings– This paper finds that the key conduct related messages in algorithmic trading compliance in the wholesale markets may not yet be fully embedded at broker–dealers. This is because of a perceived simplicity of the algorithms deployed by broker dealers or, alternatively, a lack of reflection on their impact. Conversely, a concern exists that clients’ deployment of algorithms on DEA channels provided by broker–dealers increase conduct risk. However, the threat of harm posed by clients is not envisaged in current definitions of conduct risk. Accordingly, CDR 2017/589 does not currently require firms to evaluate clients’ awareness of it. Research limitations/implications– This study’s findings are limited to the insights provided by 15 participants. Originality/value– This paper contributes to existing research by deepening understanding of conduct risk arising from algorithmic trading and DEA. To account for the potential harm arising from clients’ activities, this paper proposes a revision to Miles’sdefinition of conduct risk. This is complemented by a proposed amendment to CDR 2017/589 to require evaluation of clients’ understanding of conduct risk.
MiFIDII,, Algorithmic trading,, Market abuse, Conduct risk direct electronic access, London Metal Exchange
1358-1988
Culley, Alexander Conrad
2f899523-c2b7-473c-8ab9-3128483e732e
Culley, Alexander Conrad
2f899523-c2b7-473c-8ab9-3128483e732e

Culley, Alexander Conrad (2022) Does the deployment of algorithms combined with direct electronic access increase conduct risk? Evidence from the LME. Journal of Financial Regulation and Compliance. (doi:10.1108/JFRC-04-2022-0046). (In Press)

Record type: Article

Abstract

Purpose– The purpose of this paper is to examine the effectiveness of two regulatory initiatives in developing awareness of conduct risk associated with algorithmic and direct-electronic access (DEA) trading at broker-dealers: the UK Financial Conduct Authority’s algorithmic trading compliance in the wholesale markets and Commission Delegated Regulation 2017/589 (CDR 589) to the second Markets in Financial Instruments Directive. Design/methodology/approach– A qualitative examination of 15 semi-structured interviews with representatives of London Metal Exchangemember firms, theirclients andregulators. Findings– This paper finds that the key conduct related messages in algorithmic trading compliance in the wholesale markets may not yet be fully embedded at broker–dealers. This is because of a perceived simplicity of the algorithms deployed by broker dealers or, alternatively, a lack of reflection on their impact. Conversely, a concern exists that clients’ deployment of algorithms on DEA channels provided by broker–dealers increase conduct risk. However, the threat of harm posed by clients is not envisaged in current definitions of conduct risk. Accordingly, CDR 2017/589 does not currently require firms to evaluate clients’ awareness of it. Research limitations/implications– This study’s findings are limited to the insights provided by 15 participants. Originality/value– This paper contributes to existing research by deepening understanding of conduct risk arising from algorithmic trading and DEA. To account for the potential harm arising from clients’ activities, this paper proposes a revision to Miles’sdefinition of conduct risk. This is complemented by a proposed amendment to CDR 2017/589 to require evaluation of clients’ understanding of conduct risk.

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Accepted/In Press date: 11 July 2022
Keywords: MiFIDII,, Algorithmic trading,, Market abuse, Conduct risk direct electronic access, London Metal Exchange

Identifiers

Local EPrints ID: 470334
URI: http://eprints.soton.ac.uk/id/eprint/470334
ISSN: 1358-1988
PURE UUID: 2b89278d-2373-4501-8d02-3dd9f2f32bef
ORCID for Alexander Conrad Culley: ORCID iD orcid.org/0000-0002-0560-9443

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Date deposited: 06 Oct 2022 16:54
Last modified: 30 Jan 2023 02:55

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