SMP checks in the balance

Self-match prevention (SMP) is offered by many exchanges – CME, ICE, Turquoise and BATS among them – and by the more advanced order management systems. In most cases, employing an SMP check is voluntary for trading firms; that is important because not every prevented self-match is also a prevented (illegal) wash trade. Some regulatory jurisdictions require intent as a defining characteristic of a wash trade, but even the best technology cannot read minds. SMP checks can therefore suffer from Type I errors – statistical speak for the unnecessary rejection of a legitimate order. While more advanced SMP checks aim to reduce the frequency of these errors, there is a limit to how effective they can be before they run the risk of accepting orders that should have been rejected (aka Type II errors).

The CFTC is considering making it mandatory for exchanges to offer SMP functionality and DCMs to apply some form of SMP under RegAT. Most of us would agree that a broad implementation of SMP checks is desirable for the sake of fair and safe markets. But cancelling many legitimate orders will do little to prevent wash trades and could hurt overall market liquidity. A careful balance is needed to avoid falling foul of the regulators whilst conducting legitimate business.