top of page

Auditing Algo Trading

19 Apr 2024

The integration of automation and algorithms into the finance industry is transforming the landscape, particularly in how trading and investment services are conducted. This shift towards greater automation offers numerous benefits such as increased efficiency, reduced costs, and the ability to gain a competitive edge. However, it also introduces significant regulatory challenges, particularly under the European Union’s Markets in Financial Instruments Directive II (MiFID II), which aims to enhance transparency and fairness in financial markets.

Key Regulatory Requirements:

1. MiFID II and RTS 6: Under MiFID II, specifically Article 17, and Regulatory Technical Standard (RTS) 6, there are stringent requirements for firms engaged in algorithmic trading. These include the need for these firms to conduct annual self-assessments and validations of their trading algorithms to ensure compliance with regulatory standards. This includes algorithms that are client-facing, those that recommend or execute trades, and those used directly by the firms on various trading venues.

2. Scope and Exemptions: The scope of RTS 6 is broad, capturing any entity classified as an investment firm under MiFID II. Notably, usual exemptions available to certain entities like insurers or commodity dealers do not apply if these entities participate in regulated markets or Multilateral Trading Facilities (MTFs).

Annual Self-Assessment Process:

1. Planning: Firms need to meticulously plan their self-assessment process, involving various stakeholders such as Business Units, Compliance, Risk Management, and Internal Audit. This planning stage determines the scope, timeline, and responsibilities, setting the stage for the entire assessment process.

2. Assessment: Conducted by Control Owners, this phase involves attesting to compliance with regulatory requirements and documenting the operation of key controls. Any deficiencies identified must be addressed, with remediation plans agreed upon and documented.

3. Validation: Typically managed by the Risk Management function, this stage involves a thorough review of the compliance statements provided by the Control Owners. The validation focuses on both the design and operating effectiveness of the controls. Discrepancies or areas of non-compliance must be rigorously assessed, and further remedial actions must be defined and agreed upon.

4. Audit: The Internal Audit function reviews the validation report produced by the Risk Management function. This includes checking the appropriateness of the validation process, the conclusions reached, and ensuring that any instances of non-compliance have been effectively linked to remedial actions.

Challenges in Implementation:

Firms often encounter several challenges during these processes, including:

• Distinguishing Responsibilities: There can be confusion over separate responsibilities for assessing, validating, and auditing algorithmic trading controls.

• Resource Allocation: Identifying adequately skilled resources across the required functions is a critical challenge.

• Consistency and Clarity: Ensuring that the approach to validation and assessment is consistent across the firm is crucial to avoid discrepancies and potential regulatory scrutiny.

The role of regulatory compliance in algorithmic trading is critical not only for operational integrity but also for maintaining market stability and investor trust. Firms must navigate these regulations carefully, often requiring expert guidance to ensure thorough compliance and to mitigate the risks associated with algorithmic trading. The insights and expertise of experienced consulting firms can be invaluable in navigating these complex regulatory landscapes, ensuring that firms not only comply with current regulations but are also well-prepared for any future regulatory developments.

bottom of page