CSD’s Risk Management in HFT Era Dr. DAI Wenhua October 2013 China Securities Depository and Clearing Corporation Limited

China Securities Depository and Clearing Corporation Limited  Boom and Bust Brought by HFT  Clearing and Settlement Risks Brought by Trading Bust  How to Solve the Problem  Food for Thinking CONTENTS

China Securities Depository and Clearing Corporation Limited SME Board Main Board Boom and Bust Brought by HFT -Boom HFT Pushes Market Boom—Dark Pools, Flash Order, etc. Source: TABB Group

China Securities Depository and Clearing Corporation Limited Main Board ChiNext Boom and Bust Brought by HFT -Boom Favourable Factors for HFT—Modern Science& Technology and Digitalization Securities industry takes the brunt to be dragged into digitalization by waves of HFT, programming trade, data-based automatic regulation, individual information disclosure(micro-blog, text message, etc ).

China Securities Depository and Clearing Corporation Limited SME Board Main Board ChiNext Boom and Bust Brought by HFT -Boom Favourable Factors for HFT — Push from Rules and Regulations The US Regulation NMS The EU MiFID

China Securities Depository and Clearing Corporation Limited SME Board Main Board Boom and Bust Brought by HFT -Boom Favourable Factors for HFT—Implications of Regulation NMS and MiFID Improve market transparency, fairness and liquidity. Increase market competition and promote exchanges to be allied and company-oriented. Improve performance and connectivity of technical platforms. Promote the connections between clearing and settlement platforms. Encourage the promulgation of unified market standards.

China Securities Depository and Clearing Corporation Limited SME Board Main Board Boom and Bust Brought by HFT -Bust HFT results in trading failures. —Case Studies TimeIncidentImpactLoss Aug.23, 2013 NASDAQ 3 1/2 hours trading shutdown loss of market confidence Aug.21, 2013Goldman Sachs Erroneous Options Trades $100 million Aug.16,2013China Everbright fat finger incident a 53 % surge in volume (SHCOMP), up about 5.96% in 2 minutes $32 million May 25, 2012 NASDAQ Computer failure in the public debut of Facebook Two-hour halt $500 million for dealers May 6, 2010Wall Street flash crash DJIA plunged by 998 points, down 9.2%, the biggest daily drop $1 trillion 2005Japan Mizuho J-Com fat finger error a 301-point fall on the Nikkei 225, down almost 2% $230 million

China Securities Depository and Clearing Corporation Limited SME Board Main Board ChiNext Boom and Bust Brought by HFT -Bust New risks emerge from HFT. Unbridled science and technology will jeopardize financial market. Technology will never be perfect. Unsupervised technology will be dangerously far from perfect and the industry will be confident its technology is safe right up until it isn’t. How many more failures do regulators need to see before they stand up and do something? —— Comment: Unsupervised technology hurts modern markets, Financial Times, by RT Leuchtkafer ， August 23, 2013

China Securities Depository and Clearing Corporation Limited SME Board Main Board Clearing and Settlement Risks Brought by Trading Bust Risk Transmission Pathway Participant A Participant D Participant B Participant C CSD/CCP … … …

China Securities Depository and Clearing Corporation Limited SME Board Main Board Clearing and Settlement Risks Brought by Trading Bust Risk Management for CSD with the Function of CCP Risk Management for CSD without the Function of CCP Risk Management for DvP and Non-DvP Case study (Everbright Fat Finger incident- CCP& non- DvP )

China Securities Depository and Clearing Corporation Limited SME Board Main Board How to Solve the Problem Principles for CSD in CPSS-IOSCO PFMI Central securities depositories and exchange-of-value settlement systems Principle 11: Central securities depositories A CSD should have appropriate rules and procedures to help ensure the integrity of securities issues and minimize and manage the risks associated with the safekeeping and transfer of securities. A CSD should maintain securities in an immobilized or dematerialized form for their transfer by book entry. Principle 12: Exchange-of-value settlement systems If an FMI settles transactions that involve the settlement of two linked obligations (for example, securities or foreign exchange transactions), it should eliminate principal risk by conditioning the final settlement of one obligation upon the final settlement of the other.

China Securities Depository and Clearing Corporation Limited SME Board Main Board How to Solve the Problem PFMI are not Enough. Different regulatory principles and conditions of different markets Efforts and timetables to implement PFMI can not be unified. No risk management mechanisms for CSDs’ new Hi-tech challenges.

China Securities Depository and Clearing Corporation Limited SME Board Main Board How to Solve the Problem CSD’s Risk Prevention Capability DvP Informationized supervision and risk warning of unsecured settlement CCP+CSD central bank bailout mechanism Regulatory Authorities Strengthen control of trade measures: Regulations and rules for HFT, dark pool, and flash order, etc, license management, fuse mechanism and front-end trade control. PFMI Principle CSDs should coordinate with each other to promote the implementation of PFMI.

China Securities Depository and Clearing Corporation Limited SME Board Main Board Food for Thinking  CSD, with the function of CCP or at least having close connections with CCP, should serve as the firewall against risks as the final link in the securities trading chain.  PFMI are comprehensive and systemic in covering risk management system and various institutions. However, PFMI are not detailed enough for CSDs to tackle the new Hi-tech challenges.  CSDs should strengthen exchanges and cooperation. The establishment of the Fifth Task Force by CDCPL is of great necessity.

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