Video: Algorithm Testing under MiFID II


Francesco Lo Conte, Managing Director of Esprow, discusses challenges that firms face around the testing of trading algorithms under MiFID II, and lays out some best practices in how to address those challenges.

Video transcript:

Mike O’Hara: Hello. I’m here with Francesco Lo Conte who is the Managing Director of Esprow. Welcome, Francesco.

Francesco Lo Conte: Hi Mike.

Mike: We’re here to talk about the subject of algorithmic testing under MiFID II, now there’s been a lot of coverage in the press recently about the need to test algorithms under the new regulation, and some of the complications that may arise as a result of that.

What do you see as some of the main challenges that firms are faced with, when testing algorithms under the new regulation?

Francesco: Yes. Under MiFID II, well, actually MiFID II is a legal framework, so one of the main challenges really is to translate a legal framework into policies, and processes, and technology, so that’s been a challenge pretty much across the industry.

There’s a lot of work that’s been done by the community, for example, by the FIX Trading Community as well, into really trying to figure out what ESMA meant when they put together those regulations.

To give an example, some of the regulatory, technical standards, as part of MiFID II, like, I guess, 6 and 7, they actually demand that algorithms must be tested under stress and disorderly market conditions, but then the question arises, what does it actually mean?

For example, some of the FIX Community subgroups, they have worked also with ESMA to translate those into real technology requirements. Those are really the main challenges, understanding what the real requirements are.

Mike: What do you see as some of the, I guess, consequences for firms of not being able to address some of these challenges? What do they have to do, and what happens if they’re not able to do it?

Francesco: I think it really comes down to risk, and I usually say there are two types of risks, the old risks and the new risks. The old risks are really, like before, even before MiFID, if you don’t test, things can go wrong, and that can cost you money. Of course, you can make your client very unhappy, and also, you can manage your reputation.

To a certain extent, you can even risk the firm really, as we have seen in the past, especially in the case of algos, because the trading happens so fast, it’s almost impossible for any human being really to react fast enough to stop an algo that’s gone a little crazy, and so the losses can amount very, very quickly, so that’s like the old risks.

In the new risks, on top of all these things that can happen, you also have ESMA coming, knocking on your door, and really wanting to find out why things went wrong. In the case where you haven’t really applied the requirements, you haven’t fulfilled the requirement under MiFID II then, of course, they’re going to also apply fines, so these are the two risks.

Mike: What do you see as being some of the best practices for firms around addressing these challenges, how they’re going to do it?

Francesco: What we see in the industry really, there have been huge efforts, first of all, in really understanding what the requirements are again. Each firm has really looked internally at what they were already doing, and which areas, in fact, were more exposed to risks.

Also, one of the best practices really is to benefit from the work that’s already been done in the industry for you, like for example, by the FIX Trading Community. You’ve really got all the work for free.
There are many groups, some technical, some less technical, that have come together. They’ve really worked, with ESMA as well, to clarify many of the questions that the industry had. Really, also being part of that community, you can get a lot of the work done for you.

Mike: Key takeaways for firms when it comes to the whole topic of algorithmic testing, what are some of the key messages that you think you need to drive home?

Francesco: I would say, first of all, really understand what part of the technology in your firm already fulfilled those requirements, and which parts are more exposed to risks.
The second one, I would say get involved in the industry, and the third one, also, don’t be afraid to partner with vendors, who might have already done a lot of work into actually building the technology to implement and fulfil those requirements.

Mike: Great. Francesco Lo Conte from Esprow, thank you very much.

Francesco: Thank you Mike.