UK Prudential Regulation Authority clarifies policy on algorithmic trading

Maria Nikolova

The new rules, which become effective on June 30, 2018, apply to all algorithmic trading activities of a firm including in respect of unregulated financial instruments such as spot foreign exchange (FX).

After a consultation on the proposed new rules for algorithmic trading firms, the UK Prudential Regulation Authority (PRA) has earlier today published its Policy Statement (PS) and final Supervisory Statement (SS) concerning these rules.

The statements are relevant to firms that engage in algorithmic trading and that are subject to the rules in the Algorithmic Trading Part of the PRA Rulebook (the ‘Algorithmic Trading Part’) and Commission Delegated Regulation EU 2017/589. They apply to all algorithmic trading activities of a firm including in respect of unregulated financial instruments such as spot foreign exchange (FX).

Let’s recall that the new rules require a firm to have an algorithmic trading policy which must:

  • identify the firm’s algorithmic trading activity, including where it is undertaken within the firm;
  • define the term ‘algorithm’ as used by the firm in the context of algorithmic trading;
  • prescribe the process for the approval and decommissioning of an algorithm;
  • outline the testing and validation process for algorithmic trading, including who has responsibility for these activities.
  • set out minimum requirements for the monitoring and risk management of algorithmic trading, including escalation procedures relating to limit breaches.

The PR will also require a firm to have manual and automated controls that stop trading or prevent user access and with manual intervention required to re-start trading, that is, ‘kill-switch’ controls. The list of expectations also concerns testing of algorithms and risk controls. Prior to any algo deployment, the PRA expects, at a minimum, a firm to assess the latency of the algorithmic trading system. The firm has to ensure that the latency does not adversely impact operations, including the intended operation of the risk controls.

In the documents published today, the PRA explains that, following consideration of respondents’ comments, it has made some changes to the Supervisory Statement.

Regarding the algorithm approval process, the rules have been amended to make it clear that the PRA’s expectation is that each function that has a role in the approval of algorithms (eg Front Office, Risk Management, and Other Systems and Controls functions) should sign off on the risks relevant to them. Some respondents had interpreted this paragraph to mean that each function should sign off on all risks that an algorithm could expose the firm to.

In respect of testing and deployment, the proposed rules have been amended to clarify that, when testing algorithms, firms are only expected to document material differences between the test environment and production environment rather than all differences.

With respect to inventories and documentation, the rules have been changed to show that the expectation is that inventories and documentation will be available, rather than ‘immediately available’, to all personnel who have responsibility for the oversight of algorithmic trading.

The PRA notes that for non-EEA (‘third-country’) firms operating in the United Kingdom through a branch, the regulator will continue to follow the approach set out in SS1/18 “International banks: the Prudential Regulation Authority’s approach to branch authorisation and supervision” and will continue to consider the home regulator’s approach to internal governance and controls.

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