The Securities and Futures Commission (SFC) has reprimanded and fined Interactive Brokers Hong Kong Limited (IBHK) $4.5 million after resolving concerns over IBHK’s breaches of the Code of Conduct in its execution of market orders using electronic and algorithmic trading systems (Notes 1 & 2).
The SFC’s disciplinary action followed two market disruption incidents in 2015 and 2016 where the share prices of Hong Kong-listed O-Net Communications (Group) Limited and AAG Energy Holdings Limited were ramped up by 48.7 per cent and 126 per cent, respectively, in less than two minutes.
In light of the incidents, the SFC and IBHK jointly engaged an independent reviewer to review IBHK’s electronic and algorithmic trading systems, in particular, the controls to monitor and prevent the generation of or passing to the market for execution order instructions which may interfere with the operation of a fair and orderly market.
The review found that, in the two incidents, IBHK executed market orders by placing the entire order volume to the market and repeatedly submitting the unexecuted part of the order at the next available price until the entire order was completed. It also found that IBHK did not take into account the liquidity of the market when executing the market orders. Furthermore, IBHK failed to put in place effective price and volume controls to prevent its execution of market orders from disrupting the market (Note 3).
In respect of IBHK’s electronic and algorithmic trading systems, the review indicated that:
- IBHK’s electronic trading system was developed by its head office in the United States, where its programming function was responsible for both development and quality assurance of the system. IBHK did not conduct adequate user acceptance testing on the system; and
- the technical design documents of the systems were high level and did not provide a detailed explanation of the components of the trading systems. A specific example is that IBHK did not keep adequate records in relation to the design, development, deployment or operation of the order cancellation functionality in its electronic trading system (Note 4).
In reaching the resolution, the SFC took into account that IBHK:
- involved their senior management in the liaison with the SFC about the regulatory concerns;
- took the initiative to bring this matter to a conclusion by fully and frankly discussing the regulatory concerns with the SFC;
- undertook a review with the SFC to address the regulatory concerns and identify the deficiencies in its internal controls; and
- co-operated with the disciplinary action by resolving the SFC’s regulatory concerns.
The SFC also took into consideration IBHK’s board of directors have undertaken that reasonable steps will be implemented to ensure IBHK’s compliance with the regulatory requirements for electronic and algorithmic trading, and the failures set out above will be rectified within 12 months. Otherwise, similar failures would have resulted in a substantially higher level of fine.
IBHK is licensed under the Securities and Futures Ordinance to carry on business in Type 1 (dealing in securities), Type 2 (dealing in futures contracts) and Type 3 (leveraged foreign exchange trading) regulated activities.
Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct).
Among others, paragraph 3.3.1 of Schedule 7 to the Code of Conduct provides that a licensed person should have controls that are reasonably designed to monitor and prevent the generation of or passing to the market for execution order instructions from its algorithmic trading system which may interfere with the operation of a fair and orderly market.
Paragraph 3.2 of Schedule 7 to the Code of Conduct provides that a licensed person should ensure that the algorithmic trading system and trading algorithms it uses or provides to clients for use are adequately tested to ensure that they operate as designed. Paragraphs 1.3 and 3.4 of Schedule 7 to the Code of Conduct provide that a licensed person should keep, or cause to be kept, proper records on the design, development, deployment and operation of its electronic trading system.