The practical consequences of the transformation of the UK fixed income, currency, and commodity markets (“FICC”) into algorithmic realms for the management of conduct risk

Abstract

Financial markets have been transformed into algorithmic realms, which have radically altered humans' role in trading liquid financial instruments. Compliance officers, risk analysts, and developers have become essential stakeholders in a firm’s execution or trading algorithms deployment. Senior managers, usually operating several layers above the front lines, struggle to set a tone for the conduct of business that will resonate. Previously, exchange enforcers largely only had to concern themselves with the behaviour of floor traders. Nowadays, they must detect and deter misbehaviour from a much broader constituency that includes non-member participants worldwide.

This thesis employs qualitative research techniques to explore the implications of these shifts for the management of conduct risk. Conduct risk is a relatively new concept in the regulation of financial markets, having emerged as a distinct risk category in the aftermath of the 2007-08 financial crisis. Governments legislated to introduce personal accountability regimes to “hardwire” new expectations to identify and mitigate conduct risk. Nevertheless, the effectiveness of these arrangements is already being tested by digitisation.

In 2021, 35 semi-structured interviews were conducted with representatives from (primarily UK-based) investment firms, technology vendors, consulting firms, and regulators. The interview data was supplemented by secondary data from firms’ websites and other sources. This included the analysis of 799 enforcement notices published by four key derivatives exchanges.

Key findings from the research include (1) high alignment between firms’ public value statements and their employees’ understanding of conduct risk; (2) low penetration of some priorities on regulators’ agendas; (3) a good understanding of some technical requirements introduced to manage algorithmic conduct risk, counterbalanced by potential fatigue, complacency, cost pressures and concern about the ability to control clients’ deployment of algorithms; and (4) that the effectiveness of exchanges’ enforcement efforts in reducing conduct risk is a mixed picture. Multiple recommendations for practice are made based on the findings.

The thesis makes several contributions to knowledge. First, it helps to deepen the understanding of conduct risk in non-bank, non-securities trading environments. Second, it examines for the first time the effectiveness of some aspects of post-crisis regulatory initiatives. Third, the thesis shifts the lens through which the effectiveness of exchange enforcement is scrutinised from a legal to a behavioural one.

More information

Identifiers

ORCID for Alexander Conrad Culley: orcid.org/0000-0002-0560-9443

ORCID for Simon Wolfe: orcid.org/0000-0001-9815-9535

ORCID for Frank McGroarty: orcid.org/0000-0003-2962-0927

Catalogue record

Export record