Hong Kong regulator fines Interactive Brokers over deficiencies in electronic and algorithmic trading systems

Hong Kong’s Securities and Futures Commission (SFC) has earlier today announced that it is sanctioning Interactive Brokers Hong Kong Limited (IBHK) over deficiencies in its electronic and algorithmic trading systems.

The company was fined $4.5 million pursuant to section 194 of the Securities and Futures Ordinance (SFO), following an agreement pursuant to section 201 of the SFO dated February 6, 2018.

The action stems from two market disruption incidents in 2015 and 2016. According to the Hong Kong regulator, notwithstanding the duties to act in the interests of market integrity and prevent orders from unduly impacting the market, the share price of O-Net Communications (Group) Limited (stock code: 877) was ramped up by 48.7% from $1.97 to $2.93 in 101 seconds when IBHK was executing for client a market order to buy 500,000 shares on October 23, 2015.

Later, on July 12, 2016, the share price of AAG Energy Holdings Limited (stock code: 2686) was ramped up by 126% from $1.15 to $2.60 in 84 seconds when IBHK was executing for client a market order to buy 200,000 shares.

The SFC explains that a market order is generally understood to be an order to be executed immediately at the best available price. The HKEx does not accept such orders during the continuous trading session. Instead, licensed corporations may use the enhanced limit order or the special limit order to simulate a market order.

Executing market orders through an algorithmic trading system that does not have reasonably designed controls may cause fluctuation to share prices and result in undue market impact. Such undue market impact could be controlled by, for example:

• (a) limiting the number of attempts in resubmitting the unexecuted quantities of a market order for matching in the market; or
• (b) by restricting the execution of market orders to a maximum number of spreads from the prevailing nominal price.

Any unfilled quantity of the market order will be cancelled after the predetermined number of attempts or the maximum number of spreads was reached.

Following the above-mentioned market incidents in October 2015 and July 2016, the SFC and IBHK jointly engaged an independent reviewer to review IBHK’s electronic and algorithmic trading systems. 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.

In addition, IBHK failed to put in place effective price and volume controls to prevent its execution of market orders from disrupting the market. As such, the SFC is of the view that IBHK had failed to comply with the Code of Conduct.

The review also found that IBHK’s electronic trading system was developed by its head office in the United States. IBHK did not conduct adequate user acceptance testing on the trading system. Also, the technical design documents of the systems 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.

The SFC notes that it 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.