South Korea exchange rushes to implement ‘kill switch’ designed to minimise the fallout from trading algorithms going wrong after a local broker was brought to the brink of bankruptcy by erroneous electronic trades this month

December 30, 2013 12:25 pm

South Korea exchange rushes to implement ‘kill switch’

By Song Jung-a in Seoul and Jeremy Grant in Singapore

South Korea’s exchange operator, Korea Exchange (KRX), is rushing to implement a “kill switch” system designed to minimise the fallout from trading algorithms going wrong after a local broker was brought to the brink of bankruptcy by erroneous electronic trades this month.HanMag Securities, a local derivatives broker, faces collapse after suffering a loss of Won46.2bn ($4.3m), after entering thousands of erroneous trades in Kospi options. It is the first time a South Korean securities group faces bankruptcy due to erroneous electronic trades.

The episode highlights how the unintended consequences of advanced trading technology are starting to emerge in Asia, where regulators have only recently begun to grapple with the issue.

China’s securities regulator in August hit Everbright Securities with a record Rmb523m ($85m) fine after a probe by the Chinese Securities Regulatory Commission into an electronic trading error that had caused a sudden spike in stock prices in Shanghai.

The episode in Korea also shows the difficulties faced by foreign banks and brokers operating in markets that have yet to adopt the level of risk management systems commonly used in the US and Europe.

HanMag said it made a total of 36,100 orders by mistake on December 12, involving mostly foreign counterparties. The company is on the verge of bankruptcy after failing to settle most of the transactions. It has about Won20bn of equity capital.

Two people familiar with the case said the foreign counterparties – most of them banks – have been frustrated by KRX not immediately cancelling the erroneous trades, as is customary on most exchanges as a way of allowing a period in which to establish what happened and pave the way for restitution.

However, a KRX official told the Financial Times that HanMag had applied for cancellation only in connection with one order in Kospi 200 options that had led to a Won550m loss – much smaller than the minimum loss of Won1bn required for the exchange to take such action.

Counterparties to the erroneous transactions would also need to agree to having them cancelled. “They did not apply for the bailout for all its mistaken orders, probably for some internal reasons,” a KRX official said. HanMag declined to comment.

The official said KRX would in February implement a “kill switch” system to deal with such incidents. In South Korea, algorithms are widely used in the futures markets but not in cash equities.

The exchange said it would be able to cancel all erroneous orders from pre-registered algorithmic trading accounts before the orders were settled, and block additional orders from the accounts to prevent further losses, if its members requested this.

The Singapore Exchange is also set to implement “circuit breakers” around the same time, to prevent wild swings in share prices.

The measures come as some regulators in Asia are examining how exchanges or their customers should handle algorithms. Next month new rules come into force in Hong Kong requiring that not only brokers providing trading algorithms but also their clients – such as fund managers – understand how they work.