Some firms using computers to trade at ultra-fast speeds are not applying safeguards required to avert market meltdowns, Britain's Financial Conduct Authority (FCA) has said.
Algorithmic or high-frequency trading uses computers to automatically place an order in financial markets, without human intervention, and represents sizeable volume on stock markets.
The FCA reviewed algorithmic trading, which some critics have blamed for sharp price moves, at about a dozen firms and found some were failing to properly apply mandatory safeguards.
Sterling's "flash crash" in Asian trading in October 2016 for instance was blamed by some on algorithmic trading, but a central bank report later concluded there was no single perpetrator.
"Firms should consider and act on (the review's) content in the context of good practice for their business," Megan Butler, the FCA's director of wholesale supervision, said.
Some firms were unable to show that their systems are tested and operating properly, a requirement since January under the European Union's MiFID II securities law.
"Additionally, firms need to do more work to identify and reduce potential conduct risks created by their algorithmic trading strategies," the FCA said in a report.
The FCA did not propose new rules but will "proactively" supervise and monitor algorithmic trading, adding that firms need to consider the combined impact multiple strategies may have on the fair and effective operation of financial markets.
The FIA European Principal Traders Association (EPTA) said the FCA review was done before MiFID II came into force, adding that as members trade their own money, they have a strong focus on risk management.
The FCA said last year it would not take enforcement action straight away as long as firms were making efforts to comply with MiFID. Neil Robson, a lawyer at Katten Muchin Rosenman, said Monday's statement suggested regulatory forbearance may be short lived.
In a related move on Monday, the Bank of England published a consultation paper on what it expects from firms it authorizes regarding the management of risks from algorithmic trading.
"It applies to all algorithmic trading activities of a firm, including in respect of unregulated financial instruments such as spot foreign exchange," the BoE's Prudential Regulation Authority said in a statement.
FIA EPTA Secretary General Piebe Teeboom said it was important that all players in algorithmic trading are subject to the same requirements and high levels of market conduct.
All firms should name a senior person who is responsible for algorithmic trading, and branches of foreign banks in Britain will have to show they are properly managing risks.
The PRA guidance will come into effect in June and the regulator will publish a discussion paper on operational resilience in algorithmic trading later this year.
(Additional reporting by Maiya Keidan; Editing by Alexander Smith and David Holmes)